SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] For the fiscal year ended December 31, 2005 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition period from _______________ to ______________ Commission File Number: 1-8351 CHEMED CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 31-0791746 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 2600 Chemed Center, 255 East Fifth Street, Cincinnati, Ohio 45202-4726 (Address of principal executive offices) (Zip Code) (513) 762-6900 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ----------------------- Capital Stock - Par Value $1 Per Share New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No ----- ----- Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X ----- ----- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes No X ----- ----- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer X ----- Accelerated filer _____ Non-accelerated filer ______ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the average bid and asked price of said stock on the New York Stock Exchange - Composite Transaction Listing on June 30, 2005 ($41.37 per share), was $1,046,013,477. At March 8, 2006, 26,236,872 shares of Chemed Capital Stock (par value $1 per share) were outstanding. DOCUMENTS INCORPORATED BY REFERENCE DOCUMENT WHERE INCORPORATED -------- ------------------ 2005 Annual Report to Stockholders (specified portions) Parts I, II and IV Proxy Statement for Annual Meeting to be held May 15, 2006 Part III
CHEMED CORPORATION 2005 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PAGE ---- PART I Item 1. Business........................................................ 1 Item 1A. Risk Factors.................................................... 15 Item 1B. Unresolved Staff Comments....................................... 26 Item 2. Properties...................................................... 26 Item 3. Legal Proceedings............................................... 27 Item 4. Submission of Matters to a Vote of Security Holders............. 27 -- Executive Officers of the Registrant............................ 27 PART II Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities... 28 Item 6. Selected Financial Data......................................... 29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 29 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...... 30 Item 8. Financial Statements and Supplementary Data..................... 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................. 30 Item 9A. Controls and Procedures......................................... 30 Item 9B. Other Information............................................... 31 PART III Item 10. Directors and Executive Officers of the Registrant.............. 31 Item 11. Executive Compensation.......................................... 31 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...................... 31 Item 13. Certain Relationships and Related Transactions.................. 31 Item 14. Principal Accountant Fees and Services.......................... 31 PART IV Item 15. Exhibits and Financial Statement Schedules...................... 33
ITEM 1. BUSINESS GENERAL The Company was incorporated in Delaware in 1970 as a subsidiary of W. R. Grace & Co. and succeeded to the business of W. R. Grace & Co.'s Specialty Products Group as of April 30, 1971 and remained a subsidiary of W. R. Grace & Co. until March 10, 1982. As used herein, "Company" refers to Chemed Corporation, and its subsidiaries and "Grace" refers to W. R. Grace & Co. and its subsidiaries. On March 10, 1982, the Company transferred to Dearborn Chemical Company, a wholly owned subsidiary of the Company, the business and assets of the Company's Dearborn Group, including the stock of certain subsidiaries within the Dearborn Group, plus $185 million in cash, and Dearborn Chemical Company assumed the Dearborn Group's liabilities. Thereafter, on March 10, 1982 the Company transferred all of the stock of Dearborn Chemical Company to Grace in exchange for 33,481,604 shares of the capital stock of the Company owned by Grace with the result that Grace no longer has any ownership interest in the Company. On December 31, 1986, the Company completed the sale of substantially all of the business and assets of Vestal Laboratories, Inc., a wholly owned subsidiary. The Company received cash payments aggregating approximately $67.4 million over the four-year period following the closing, the substantial portion of which was received on December 31, 1986. On April 2, 1991, the Company completed the sale of DuBois Chemicals, Inc. ("DuBois"), a wholly owned subsidiary, to the Diversey Corporation ("Diversey"), then a subsidiary of The Molson Companies Ltd. Under the terms of the sale, Diversey agreed to pay the Company net cash payments aggregating $223,386,000, including deferred payments aggregating $32,432,000. On December 21, 1992, the Company acquired The Veratex Corporation and related businesses ("Veratex Group") from Omnicare, Inc. The purchase price was $62,120,000 in cash paid at closing, plus a post-closing payment of $1,514,000 (paid in April 1993) based on the net assets of Veratex. Effective January 1, 1994, the Company acquired all the capital stock of Patient Care, Inc. ("Patient Care"), for cash payments aggregating $20,582,000, plus 35,000 shares of the Company's Capital Stock. An additional cash payment of $1,000,000 was made on March 31, 1996 and another payment of $1,000,000 was made on March 31, 1997. In July 1995, the Company's Omnia Group (formerly Veratex Group) completed the sale of the business and assets of its Veratex Retail division to Henry Schein, Inc. ("HSI") for $10 million in cash plus a $4.1 million note for which payment was received in December 1995. Effective September 17, 1996, the Company completed a merger of a subsidiary of the Company, Chemed Acquisition Corp., and Roto-Rooter, Inc. pursuant to a Tender Offer commenced on August 8, 1996 to acquire any and all of the outstanding shares of Common Stock of Roto-Rooter, Inc. for $41.00 per share in cash. On September 24, 1997, the Company completed the sale of its wholly owned businesses comprising the Omnia Group to Banta Corporation for $50 million in cash and $2.3 million in deferred payments. Effective September 30, 1997, the Company completed a merger between its 81-percent-owned subsidiary, National Sanitary Supply Company, and a wholly owned subsidiary of Unisource Worldwide, Inc. for $21.00 per share, with total payments of $138.3 million. Effective October 11, 2002, the Company sold its Patient Care subsidiary ("Patient Care") to an investor group that included Schroder Ventures Life Sciences Group, Oak Investment Partners, Prospect Partners and Salix Ventures. Patient Care provides home-healthcare services primarily in the New York-New Jersey-Connecticut area. The cash proceeds to the Company totaled $57,500,000, of which $5,000,000 was placed in escrow pending settlement of Patient Care's receivables with third-party payers. Of this amount, $2,500,000 was distributed as of October 2003 and the remainder, except for $769,042 was 1
distributed as of October 2004. The Company is also entitled to additional funds based on the estimated balance sheet valuation. This claim is currently in litigation. In addition, the Company received a senior subordinated note receivable ("Note") for $12,500,000 and a common stock purchase warrant ("Warrant") for 2% of the outstanding stock of the purchasing company. The Note is due October 11, 2007, and bears interest at the annual rate of 7.5% through September 30, 2004, 8.5% from October 1, 2004, through September 30, 2005, and 9.5% thereafter. The Warrant has an estimated fair value of $1,445,000. Effective February 24, 2004, The Company completed a merger of its wholly owned indirect subsidiary, Marlin Merger Corp., and Vitas Healthcare Corporation. Under the terms of the merger agreement, Vitas stockholders received cash of $30.00 per share. The transaction, including the refinancing of existing Vitas debt and other payments made in connection with the merger, totaled approximately $415 million in cash. In order to complete the merger the Company sold four million shares of its Capital Stock in a private placement at a price of $25.00 per share, issued $110 million principal amount of floating rate senior secured notes due 2010 ("Floating Rate Notes"), issued $150 million principal amount of 8.75% Senior Notes due 2011 ("Fixed Rate Notes"), and entered into new $135 million senior secured credit facilities. These obligations were restated on February 24, 2005. More information with respect to the Company's merger with Vitas is included within Note 7 of the Notes to Consolidated Financial Statements appearing on pages 23-25 of the Annual Report to Stockholders and incorporated herein by reference. On December 22, 2004, the Board of Directors authorized the discontinuance of the operations of the Company's Service America segment, through an asset sale to employees of Service America. The acquiring corporation purchased a substantial majority of Service America's assets in exchange for assuming substantially all of Service America's liabilities in May 2005. Included in the assets acquired was a receivable from the Company for approximately $4.7 million. The Company paid $1 million of the receivable upon closing and the remainder is payable over the following year in 11 equal monthly installments. During 2005 the Company conducted its business operations in two segments: Vitas Group ("Vitas") and Roto-Rooter Group ("Roto-Rooter"). FORWARD LOOKING STATEMENTS This Annual Report contains or incorporates by reference certain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends such statements to be subject to the safe harbors created by that legislation. Such statements involve risks and uncertainties that could cause actual results of operations to differ materially from these forward looking statements. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS The required segment and geographic data for the Company's continuing operations (as described below) for the three years ended December 31, 2003, 2004 and 2005 are shown in Note 2 of the Notes to Consolidated Financial Statements on pages 17-19 of the 2005 Annual Report to Stockholders and are incorporated herein by reference. DESCRIPTION OF BUSINESS BY SEGMENT The information called for by this item is included within Note 2 of the Notes to Consolidated Financial Statements appearing on pages 17-19 of the 2005 Annual Report to Stockholders and is incorporated herein by reference. PRODUCT AND MARKET DEVELOPMENT Each segment of the Company's business engages in a continuing program for the development and marketing of new services and products. While new products and services and new market development are important factors for the growth of each active segment of 2
the Company's business, the Company does not expect that any new products and services or marketing effort, including those in the development stage, will require the investment of a material amount of the Company's assets. RAW MATERIALS The principal raw materials needed for the Company's manufacturing operations are purchased from United States sources. No segment of the Company experienced any material raw material shortages during 2005, although such shortages may occur in the future. Products manufactured and sold by the Company's Roto-Rooter segment generally may be reformulated to avoid the adverse impact of a specific raw material shortage. PATENTS, SERVICE MARKS AND LICENSES The Roto-Rooter(R) trademarks and service marks have been used and advertised since 1935 by Roto-Rooter Corporation, a wholly owned indirect subsidiary of the Company. The Roto-Rooter(R) marks are among the most highly recognized trademarks and service marks in the United States. The Company considers the Roto-Rooter(R) marks to be a valuable asset and a significant factor in the marketing of Roto-Rooter's franchises, products and services and the products and services provided by its franchisees. "Vitas" and "Innovative Hospice Care" are trademarks and servicemarks of Vitas Healthcare Corporation. The Company and its subsidiaries also own certain trade secrets including training manuals, pricing information, customer information and software source codes. COMPETITION ROTO-ROOTER All aspects of the sewer, drain, and pipe cleaning, HVAC services and plumbing repair businesses are highly competitive. Competition is, however, fragmented in most markets with local and regional firms providing the primary competition. The principal methods of competition are advertising, range of services provided, name recognition, speed and quality of customer service, service guarantees, and pricing. No individual customer or market group is critical to the total sales of this segment. VITAS Hospice care in the United States is competitive. Because payments for hospice services are generally uniform, Vitas competes primarily on the basis of its ability to deliver quality, responsive services. Vitas is the nation's largest provider of hospice services in a market dominated by small, non-profit, community-based hospices. Approximately 60% of all hospices are not-for-profit. Because the hospice care market is highly fragmented, Vitas competes with a large number of organizations. Vitas also competes with a number of national and regional hospice providers, including Odyssey Healthcare, Inc. and VistaCare, Inc., hospitals, nursing homes, home health agencies and other health care providers. Many providers offer home care to patients who are terminally ill, and some actively market palliative care and hospice-like programs. In addition, various health care companies have diversified into the hospice market. Some of these health care companies may have greater financial resources than Vitas. Relatively few barriers to entry exist in the markets served by Vitas. Accordingly, other companies that are not currently providing hospice care may enter these markets and expand the variety of services offered. 3
RESEARCH AND DEVELOPMENT The Company engages in a continuous program directed toward the development of new services, products and processes, the improvement of existing services, products and processes, and the development of new and different uses of existing products. The research and development expenditures from continuing operations have not been nor are they expected to be material. GOVERNMENT REGULATIONS ROTO-ROOTER Roto-Rooter's franchising activities are subject to various federal and state franchising laws and regulations, including the rules and regulations of the Federal Trade Commission (the "FTC") regarding the offering or sale of franchises. The rules and regulations of the FTC require that Roto-Rooter provide all prospective franchisees with specific information regarding the franchise program and Roto-Rooter in the form of a detailed franchise offering circular. In addition, a number of states require Roto-Rooter to register its franchise offering prior to offering or selling franchises in the state. Various state laws also provide for certain rights in favor of franchisees, including (i) limitations on the franchisor's ability to terminate a franchise except for good cause, (ii) restrictions on the franchisor's ability to deny renewal of a franchise, (iii) circumstances under which the franchisor may be required to purchase certain inventory of franchisees when a franchise is terminated or not renewed in violation of such laws, and (iv) provisions relating to arbitration. Roto-Rooter's ability to engage in the plumbing repair business is also subject to certain limitations and restrictions imposed by state and local licensing laws and regulations. VITAS General. The health care industry and Vitas' hospice programs are subject to extensive federal and state regulation. Vitas' hospices are licensed as required under state law as either hospices or home health agencies, or both, depending on the regulatory requirements of each particular state. In addition, Vitas' hospices are required to meet certain conditions of participation to be eligible to receive payments as hospices under the Medicare and Medicaid programs. All of Vitas' hospices, other than those currently in development, are certified for participation as hospices in the Medicare program, and are also eligible to receive payments as hospices from the Medicaid program in each of the states in which Vitas operates. Vitas' hospices are subject to periodic survey by governmental authorities or private accrediting entities to assure compliance with state licensing, certification and accreditation requirements, as the case may be. Medicare Conditions of Participation. Federal regulations require that a hospice program satisfy certain conditions of participation to be certified and receive Medicare payment for the services it provides. Failure to comply with the conditions of participation may result in sanctions, up to and including decertification from the Medicare program. See "Surveys and Audits" below. The Medicare conditions of participation for hospice programs include the following: Governing Body. Each hospice must have a governing body that assumes full responsibility for the policies and the overall operation of the hospice and for ensuring that all services are provided in a manner consistent with accepted standards of practice. The governing body must designate one individual who is responsible for the day-to-day management of the hospice. Medical Director. Each hospice must have a medical director who is a physician and who assumes responsibility for overseeing the medical component of the hospice's patient care program. 4
Direct Provision of Core Services. Medicare limits those services for which the hospice may use individual independent contractors or contract agencies to provide care to patients. Specifically, substantially all nursing, social work, and counseling services must be provided directly by hospice employees meeting specific educational and professional standards. During periods of peak patient loads or under extraordinary circumstances, the hospice may be permitted to use contract workers, but the hospice must agree in writing to maintain professional, financial and administrative responsibility for the services provided by those individuals or entities. Professional Management of Non-Core Services. A hospice may arrange to have non-core services such as therapy services, home health aide services, medical supplies or drugs provided by a non-employee or outside entity. If the hospice elects to use an independent contractor to provide non-core services, however, the hospice must retain professional management responsibility for the arranged services and ensure that the services are furnished in a safe and effective manner by qualified personnel, and in accordance with the patient's plan of care. Plan of Care. The patient's attending physician, the medical director or designated hospice physician, and the interdisciplinary team must establish an individualized written plan of care prior to providing care to any hospice patient. The plan must assess the patient's needs and identify services to be provided to meet those needs and must be reviewed and updated at specified intervals. Continuation of Care. A hospice may not discontinue or reduce care provided to a Medicare beneficiary if the individual becomes unable to pay for that care. Informed Consent. The hospice must obtain the informed consent of the hospice patient, or the patient's legal representative, that specifies the type of care services that may be provided as hospice care. Training. A hospice must provide ongoing training for its employees. Quality Assurance. A hospice must conduct ongoing and comprehensive self-assessments of the quality and appropriateness of care it provides and that its contractors provide under arrangements to hospice patients. Interdisciplinary Team. A hospice must designate an interdisciplinary team to provide or supervise hospice care services. The interdisciplinary team develops and updates plans of care, and establishes policies governing the day-to-day provision of hospice services. The team must include at least a physician, registered nurse, social worker and spiritual or other counselor. A registered nurse must be designated to coordinate the plan of care. Volunteers. Hospice programs are required to recruit and train volunteers to provide patient care services or administrative services. Volunteer services must be provided in an amount equal to at least five percent of the total patient care hours provided by all paid hospice employees and contract staff. Licensure. Each hospice and all hospice personnel must be licensed, certified or registered in accordance with applicable federal, state and local laws and regulations. Central Clinical Records. Hospice programs must maintain clinical records for each hospice patient that are organized in such a way that they may be easily retrieved. The clinical records must be complete and accurate and protected against loss, destruction, and unauthorized use. Surveys and Audits. Hospice programs are subject to periodic survey by federal and state regulatory authorities and private accrediting entities to ensure compliance with applicable licensing and certification requirements and accreditation standards. 5
Regulators conduct periodic surveys of hospice programs and provide reports containing statements of deficiencies for alleged failure to comply with various regulatory requirements. Survey reports and statements of deficiencies are common in the healthcare industry. In most cases, the hospice program and regulatory authorities will agree upon any steps to be taken to bring the hospice into compliance with applicable regulatory requirements. In some cases, however, a state or federal regulatory authority may take a number of adverse actions against a hospice program, including the imposition of fines, temporary suspension of admission of new patients to the hospice's service or, in extreme circumstances, de-certification from participation in the Medicare or Medicaid programs or revocation of the hospice's license. From time to time Vitas receives survey reports containing statements of deficiencies. Vitas reviews such reports and takes appropriate corrective action. Vitas believes that its hospices are in material compliance with applicable licensure and certification requirements. If a Vitas hospice were found to be out of compliance and actions were taken against a Vitas hospice, they could materially adversely affect the hospice's ability to continue to operate, to provide certain services and to participate in the Medicare and Medicaid programs, which could materially adversely affect Vitas. Billing Audits/ Claims Reviews. The Medicare program and its fiscal intermediaries and other payors periodically conduct pre-payment or post-payment reviews and other reviews and audits of health care claims, including hospice claims. There is pressure from state and federal governments and other payors to scrutinize health care claims to determine their validity and appropriateness. In order to conduct these reviews, the payor requests documentation from Vitas and then reviews that documentation to determine compliance with applicable rules and regulations, including the eligibility of patients to receive hospice benefits, the appropriateness of the care provided to those patients and the documentation of that care. During the past several years, Vitas' claims have been subject to review and audit. Certificate of Need Laws and Other Restrictions. Some states, including Florida, have certificate of need or similar health planning laws that apply to hospice care providers. These states may require some form of state agency review or approval prior to opening a new hospice program, to adding or expanding hospice services, to undertaking significant capital expenditures or under other specified circumstances. Approval under these certificate of need laws is generally conditioned on the showing of a demonstrable need for services in the community. Vitas may seek to develop, acquire or expand hospice programs in states having certificate of need laws. To the extent that state agencies require Vitas to obtain a certificate of need or other similar approvals to expand services at existing hospice programs or to make acquisitions or develop hospice programs in new or existing geographic markets, Vitas' plans could be adversely affected by a failure to obtain such certificate or approval. In addition, competitors may seek administratively or judicially to challenge such an approval or proposed approval by the state agency, and Vitas has been defending against such a challenge in connection with the development of its Palm Beach County, Florida hospice program. Such a challenge, whether or not ultimately successful, could adversely affect Vitas. Limitations on For-Profit Ownership. A few states have laws that restrict the development and expansion of for-profit hospice programs. For example, Florida law does not permit the operation of a hospice by a for-profit corporation unless it was operated in that capacity on or before July 1, 1978, although under certain circumstances a for-profit corporation may be permitted to purchase a grandfathered hospice program and continue to operate it. In New York, a hospice generally cannot be owned by a corporation that has another corporation as a stockholder. These types of restrictions could affect Vitas' ability to expand in Florida or into New York, or in other jurisdictions with similar restrictions. Limits on the Acquisition or Conversion of Non-Profit Health Care Organizations. An increasing number of states have enacted laws that restrict the ability of for-profit entities to acquire or otherwise assume the operations of a non-profit health care provider. Some states may require government review, public hearings, and/or government approval of transactions in which a for-profit entity proposes to purchase certain non- 6
profit healthcare organizations. Heightened scrutiny of these transactions may significantly increase the costs associated with future acquisitions of non-profit hospice programs in some states, otherwise increase the difficulty in completing those acquisitions or prevent them entirely. Vitas cannot assure that it will not encounter regulatory or governmental obstacles in connection with any proposed acquisition of non-profit hospice programs in the future. Professional Licensure and Participation Agreements. Many hospice employees are subject to federal and state laws and regulations governing the ethics and practice of their profession, including physicians, physical, speech and occupational therapists, social workers, home health aides, pharmacists and nurses. In addition, those professionals who are eligible to participate in the Medicare, Medicaid or other federal health care programs as individuals must not have been excluded from participation in those programs at any time. State Licensure of Hospice. Each of Vitas' hospices must be licensed in the state in which it operates. State licensure rules and regulations require that Vitas' hospices maintain certain standards and meet certain requirements, which may vary from state to state. Vitas believes that its hospices are in material compliance with applicable licensure requirements. If a Vitas hospice were found to be out of compliance and actions were taken against a Vitas hospice, they could materially adversely affect the hospice's ability to continue to operate, to provide certain services and to participate in the Medicare and Medicaid programs, which could materially adversely affect Vitas. Overview of Government Payments -- General. Over 90% of Vitas' revenue consisted of payments from the Medicare and Medicaid programs. Such payments are made primarily on a "per diem" basis. Under the per diem reimbursement methodology, Vitas is essentially at risk for the cost of eligible services provided to hospice patients. Profitability is therefore largely dependent upon Vitas' ability to manage the costs of providing hospice services to patients. Increases in operating costs, such as labor and supply costs that are subject to inflation and other increases, without a compensating increase in Medicare and Medicaid rates, could have a material adverse effect on Vitas' business in the future. The Medicare and Medicaid programs are increasing pressure to control health care costs and to decrease or limit increases in reimbursement rates for health care services. As with most government programs, the Medicare and Medicaid programs are subject to statutory and regulatory changes, possible retroactive and prospective rate and payment adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of program payments and could have a material adverse effect on Vitas' business. Vitas' levels of revenues and profitability will be subject to the effect of legislative and regulatory changes, including possible reductions in coverage or payment rates, or changes in methods of payment, by the Medicare and Medicaid programs. Overview of Government Payments -- Medicare Medicare Eligibility Criteria. To receive Medicare payment for hospice services, the hospice medical director and, if the patient has one, the patient's attending physician, must certify that the patient has a life expectancy of six months or less if the illness runs its normal course. This determination is made based on the physician's clinical judgment. Due to the uncertainty of such prognoses, however, it is likely and expected that some percentage of hospice patients will not die within six months of entering a hospice program. The Medicare program (among other third-party payors) recognizes that terminal illnesses often do not follow an entirely predictable course, and therefore the hospice benefit remains available to beneficiaries so long as the hospice physician or the patient's attending physician continues to certify that the patient's life expectancy remains six months or less. Specifically, the Medicare hospice benefit provides for two initial 90-day benefit periods followed by an unlimited number of 60-day periods. In order to qualify for hospice care, a Medicare beneficiary must elect hospice care and waive any right to other Medicare benefits related to his or her terminal illness. A Medicare beneficiary may revoke his or her election of the Medicare hospice benefit at any time and resume receiving regular Medicare benefits. The patient may elect the hospice benefit again at a later date so long as he or she remains 7
eligible. Increased regulatory scrutiny of compliance with the Medicare six-month eligibility rule has impacted the hospice industry. The Medicare program, however, has reaffirmed that Medicare hospice beneficiaries are not limited to six months of coverage and that there is no limit on how long a Medicare beneficiary can continue to receive hospice benefits and services, provided that the beneficiary continues to meet the eligibility criteria under the Medicare hospice program. In addition, the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 requires HHS to conduct a study to examine the appropriateness of the current physician certification requirement required before a Medicare beneficiary is eligible to receive the Medicare hospice benefit. Levels of Care. Medicare pays for hospice services on a prospective payment system basis under which Vitas receives an established payment rate for each day that it provides hospice services to a Medicare beneficiary. These rates are subject to annual adjustments for inflation and vary based upon the geographic location where the services are provided. The rate Vitas receives depends on which of the following four levels of care is being provided to the beneficiary: Routine Home Care. The routine home care rate is paid for each day that a patient is in a hospice program and is not receiving one of the other categories of hospice care. The routine home care rate does not vary based upon the volume or intensity of services provided by the hospice program. General Inpatient Care. The general inpatient care rate is paid when a patient requires inpatient services for a short period for pain control or symptom management which cannot be managed in other settings. General inpatient care services must be provided in a Medicare or Medicaid certified hospital or long-term care facility or at a freestanding inpatient hospice facility with the required registered nurse staffing. Continuous Home Care. Continuous home care is provided to patients while at home, during periods of crisis when intensive monitoring and care, primarily nursing care, is required in order to achieve palliation or management of acute medical symptoms. Continuous home care requires a minimum of 8 hours of care within a 24-hour day, which begins and ends at midnight. The care must be predominantly nursing care provided by either a registered nurse or licensed practical nurse. While the published Medicare continuous home care rates are daily rates, Medicare actually pays for continuous home care services on an hourly basis. This hourly rate is calculated by dividing the daily rate by 24. Respite Care. Respite care permits a hospice patient to receive services on an inpatient basis for a short period of time in order to provide relief for the patient's family or other caregivers from the demands of caring for the patient. A hospice can receive payment for respite care for a given patient for up to five consecutive days at a time, after which respite care is reimbursed at the routine home care rate. Medicare Payment for Physician Services. Payment for direct patient care physician services delivered by hospice physicians is billed separately by the hospice to the Medicare intermediary and paid at the lesser of the actual charge or the Medicare allowable charge for these services. This payment is in addition to the daily rates Vitas receives for hospice care. Payment for hospice physicians' administrative and general supervisory activities is included in the daily rates discussed above. Payments for attending physician professional services (other than services furnished by hospice physicians) are not paid to the hospice, but rather are paid directly to the attending physician by the Medicare carrier. For fiscal 2005, 1.7% of Vitas' net revenue was attributable to physician services. Medicare Limits on Hospice Care Payments. Medicare payments for hospice services are subject to two additional limits or "caps." Each of Vitas' hospice programs is separately subject to both of these "caps." Both of these "caps" are determined on an annual basis for the period running from November 1 through October 31 of each year. 8
First, under a Medicare rule known as the "80-20" rule applicable to Medicare inpatient services, if the number of inpatient care days furnished by a hospice to Medicare beneficiaries exceeds 20% of the total days of hospice care furnished by such hospice to Medicare beneficiaries, Medicare payments to the hospice for inpatient care days exceeding the inpatient cap are reduced to the routine home care rate. Vitas has never exceeded the inpatient cap. Second, Medicare payments to a hospice are also subject to a separate cap based on overall average payments per admission. Any payments exceeding this overall hospice cap must be refunded by the hospice. This cap was set at $19,778 per admission through the twelve-month period ended on October 31, 2005, and is adjusted annually to account for inflation. There can be no assurance that Vitas' hospices will not be subject to future payment reductions or recoupments as the result of this cap. In 2005, we determined Vitas' Phoenix, AZ facility has exceeded this cap for the period ended October 31, 2005. Medicare Managed Care Programs. The Medicare program has entered into contracts with managed care companies to provide a managed care benefit to Medicare beneficiaries who elect to participate in managed care programs. These managed care programs are commonly referred to as Medicare HMOs, Medicare + Choice or Medicare risk products. Vitas provides hospice care to Medicare beneficiaries who participate in these managed care programs, and Vitas is paid for services provided to these beneficiaries in the same way and at the same rates as those of other Medicare beneficiaries who are not in a Medicare managed care program. Under current Medicare policy, Medicare pays the hospice directly for services provided to these managed care program participants and then reduces the standard per-member, per-month payment that the managed care program otherwise receives. Overview of Government Payments -- Medicaid Medicaid Coverage and Reimbursement. State Medicaid programs are another source of Vitas' net patient revenue. Medicaid is a state-administered program financed by state funds and matching federal funds to provide medical assistance to the indigent and certain other eligible persons. In 1986, hospice services became an optional state Medicaid benefit. For those states that elect to provide a hospice benefit, the Medicaid program is required to pay the hospice at rates at least equal to the rates provided under Medicare and calculated using the same methodology. States maintain flexibility to establish their own hospice election procedures and to limit the number and duration of benefit periods for which they will pay for hospice services. Nursing Home Residents. For Vitas' patients who receive nursing home care under a state Medicaid program and who elect hospice care under Medicare or Medicaid, Vitas contracts with nursing homes for the nursing homes' provision of room and board services. In addition to the applicable Medicare or Medicaid hospice daily or hourly rate, the state generally must pay Vitas an amount equal to at least 95% of the Medicaid daily nursing home rate for room and board services furnished to the patient by the nursing home. Under Vitas' standard nursing home contracts, Vitas pays the nursing home for these room and board services at the Medicaid daily nursing home rate. Adjustments to Medicare and Medicaid Payment Rates. Payment rates under the Medicare and Medicaid programs are adjusted annually based upon the Hospital Market Basket Index; however, the adjustments have historically been less than actual inflation. On October 1, 2003, the base Medicare payment rates for hospice care increased by approximately 3.4% over the base rates in effect in the prior year. On October 1, 2004 the rates increased by 3.3%. On October 1, 2005 the rates increased by 3.4%. These base rates are further modified by the Hospice Wage Index to reflect local differences in wages according to the revised wage index. It is possible that there will be further modifications to the rate structure under which the Medicare or Medicaid programs pay for hospice care services. Any future reductions in the rate of increase in Medicare and Medicaid payments may have an adverse impact on Vitas' net patient service revenue and profitability. 9
OTHER HEALTHCARE REGULATIONS Federal and State Anti-Kickback Laws and Safe Harbor Provisions. The federal Anti-Kickback Law makes it a felony to knowingly and willfully offer, pay, solicit or receive any form of remuneration in exchange for referring, recommending, arranging, purchasing, leasing or ordering items or services covered by a federal health care program including Medicare or Medicaid. The Anti-Kickback Law applies regardless of whether the remuneration is provided directly or indirectly, in cash or in kind. Although the anti-kickback statute does not prohibit all financial transactions or relationships that providers of healthcare items or services may have with each other, interpretations of the law have been very broad. Under current law, courts and federal regulatory authorities have stated that this law is violated if even one purpose (as opposed to the sole or primary purpose) of the arrangement is to induce referrals. Violations of the Anti-Kickback Law carry potentially severe penalties including imprisonment of up to five years, criminal fines of up to $25,000 per act, civil money penalties of up to $50,000 per act, and additional damages of up to three times the amounts claimed or remuneration offered or paid. Federal law also authorizes exclusion from the Medicare and Medicaid programs for violations of the Anti-Kickback Law. The Anti-Kickback Law contains several statutory exceptions to the broad prohibition. In addition, Congress authorized the Office of Inspector General ("OIG") to publish numerous "safe harbors" that exempt some practices from enforcement action under the Anti-Kickback Law and related laws. These statutory exceptions and regulatory safe harbors protect various bona fide employment relationships, contracts for the rental of space or equipment, personal service arrangements, and management contracts, among other things, provided that certain conditions set forth in the statute or regulations are satisfied. The safe harbor regulations, however, do not comprehensively describe all lawful relationships between healthcare providers and referral sources, and the failure of an arrangement to satisfy all of the requirements of a particular safe harbor does not mean that the arrangement is unlawful. Failure to comply with the safe harbor provisions, however, may mean that the arrangement will be subject to scrutiny. It is possible for healthcare providers to request an advisory opinion from the OIG regarding an existing or proposed business arrangement and the possible anti-kickback concerns raised by that arrangement. Many states, including states where Vitas does business, have adopted similar prohibitions against payments that are intended to induce referrals of patients, regardless of the source of payment. Some of these state laws lack explicit "safe harbors" that may be available under federal law. Sanctions under these state anti-kickback laws may include civil money penalties, license suspension or revocation, exclusion from the Medicare or Medicaid programs, and criminal fines or imprisonment. Little precedent exists regarding the interpretation or enforcement of these statutes. Vitas is required under the Medicare conditions of participation and some state licensing laws to contract with numerous healthcare providers and practitioners, including physicians, hospitals and nursing homes, and to arrange for these individuals or entities to provide services to Vitas' patients. In addition, Vitas has contracts with other suppliers, including pharmacies, ambulance services and medical equipment companies. Some of these individuals or entities may refer, or be in a position to refer, patients to Vitas, and Vitas may refer, or be in a position to refer, patients to these individuals or entities. These arrangements may not qualify for a safe harbor. Vitas from time to time seeks guidance from regulatory counsel as to the changing and evolving interpretations and the potential applicability of these anti-kickback laws to its programs, and in response thereto, takes such actions as it deems appropriate. The Company generally believes that Vitas' contracts and arrangements with providers, practitioners and suppliers do not violate applicable anti-kickback laws. However, the Company cannot assure that such laws will ultimately be interpreted in a manner consistent with Vitas' practices. HIPAA Anti-Fraud Provisions. HIPAA includes several revisions to existing health care fraud laws by permitting the imposition of civil monetary penalties in cases involving violations of the anti-kickback statute or contracting with excluded 10
providers. In addition, HIPAA created new statutes making it a federal felony to engage in fraud, theft, embezzlement, or the making of false statements with respect to healthcare benefit programs, which include private, as well as government programs. In addition, for the first time, federal enforcement officials have the ability to exclude from the Medicare and Medicaid programs any investors, officers and managing employees associated with business entities that have committed healthcare fraud, even if the investor, officer or employee had no actual knowledge of the fraud. OIG Fraud Alerts, Advisory Opinions and Other Program Guidance. In 1976, Congress established the OIG to, among other things, identify and eliminate fraud, abuse and waste in HHS programs. To identify and resolve such problems, the OIG conducts audits, investigations and inspections across the country and issues public pronouncements identifying practices that may be subject to heightened scrutiny. In the last several years, there have been a number of hospice related audits and reviews conducted. These reviews and recommendations have included: - better ensuring that Medicare hospice eligibility determinations are made in accordance with the Medicare regulations; and - revising the annual cap on hospice benefits to better reflect the cost of care provided. From time to time, various federal and state agencies, such as HHS and the OIG, issue a variety of pronouncements, including fraud alerts, the OIG's Annual Work Plan and other reports, identifying practices that may be subject to heightened governmental scrutiny. The Company cannot predict what, if any changes may be implemented in coverage, reimbursement, or enforcement policies as a result of these OIG reviews and recommendations. On April 7, 2005 the Company announced the Office of Inspector General ("OIG") for the Department of Health and Human Services served Vitas with civil subpoenas relating to Vitas' alleged failure to appropriately bill Medicare and Medicaid for hospice services. As part of this investigation, the OIG selected medical records for 320 past and current patients from Vitas' three largest programs for review. It also sought policies and procedures dating back to 1998 to present covering admissions, certifications, recertifications, and discharges. During the third quarter of 2005, the OIG requested additional information of the Company. The U.S. Attorney has since provided the Company with a copy of a qui tam complaint filed under seal in U.S. District Court for the Southern District of Florida. The complaint and all filings in the qui tam action remain under seal. We are conferring with the U.S. Attorney regarding the Company's defenses to the complaint allegations. The U.S. Attorney has not decided whether to intervene in the qui tam action. The Company has recorded pretax expense related to complying with OIG requests of $310,000 and $564,000 for the three and nine month periods ended September 30, 2005, respectively. The government continues to investigate the complaint's allegations. We are unable to predict the outcome of this matter or the impact, if any, that it may have on the business, results of operations, liquidity or capital resources. Regardless of outcome, responding to this matter can adversely affect the Company through defense costs, diversion of management's time and related publicity. Federal False Claims Acts. The federal law includes several criminal and civil false claims provisions, which provide that knowingly submitting claims for items or services that were not provided as represented may result in the imposition of multiple damages, administrative civil money penalties, criminal fines, imprisonment, and/or exclusion from participation in federally funded healthcare programs, including Medicare and Medicaid. In addition, the OIG may impose extensive and costly corporate integrity requirements upon a healthcare provider that is the subject of a false claims judgment or settlement. These requirements may include the creation of a formal compliance program, the appointment of a government monitor, and the imposition of annual reporting requirements and audits conducted by an independent review organization to monitor compliance with the terms of the agreement and relevant laws and regulations. 11
The Civil False Claims Act prohibits the known filing of a false claim or the known use of false statements to obtain payments. Penalties for violations include fines ranging from $5,500 to $11,000, plus treble damages, for each claim filed. Provisions in the Civil False Claims Act also permit individuals to bring actions against individuals or businesses in the name of the government as so called "qui tam" relators. If a qui tam relator's claim is successful, he or she is entitled to share in the government's recovery. Both direct enforcement activity by the government and qui tam actions have increased significantly in recent years and have increased the risk that a healthcare company may have to defend a false claims action, pay fines or be excluded from the Medicare and/or Medicaid programs as a result of an investigation arising out of this type of an action. Because of the complexity of the government regulations applicable to the healthcare industry, the Company cannot assure that Vitas will not be the subject of an action under the False Claims Act. State False Claims Laws. At least 10 states and the District of Columbia, including states in which Vitas currently operates, have adopted state false claims laws that mirror to some degree the federal false claims laws. While these statutes vary in scope and effect, the penalties for violating these false claims laws include administrative, civil and/or criminal fines and penalties, imprisonment, and the imposition of multiple damages. The Stark Law and State Physician Self-Referral Laws. Section 1877 of the Social Security Act, commonly known as the "Stark Law," prohibits physicians from referring Medicare or Medicaid patients for "designated health services" to entities in which they hold an ownership or investment interest or with whom they have a compensation arrangement, subject to a number of statutory and regulatory exceptions. Penalties for violating the Stark Law are severe and include: - denial of payment; - civil monetary penalties of $15,000 per referral or $1,000,000 for "circumvention schemes;" - assessments equal to 200% of the dollar value of each such service provided; and - exclusion from the Medicare and Medicaid programs. Hospice care itself is not specifically listed as a designated health service; however, certain services that Vitas provides, or in the future may provide, are among the services identified as designated health services for purposes of the self-referral laws. The Company cannot assure that future regulatory changes will not result in hospice services becoming subject to the Stark Law's ownership, investment or compensation prohibitions in the future. Many states where Vitas operates have laws similar to the Stark Law, but with broader effect because they apply regardless of the source of payment for care. Penalties similar to those listed above as well as the loss of state licensure may be imposed in the event of a violation of these state self-referral laws. Little precedent exists regarding the interpretation or enforcement of these statutes. Civil Monetary Penalties. The Civil Monetary Penalties Statute provides that civil penalties ranging between $10,000 and $50,000 per claim or act may be imposed on any person or entity that knowingly submits improperly filed claims for federal health benefits or that offers or makes payments to induce a beneficiary or provider to reduce or limit the use of health care services or to use a particular provider or supplier. Civil monetary penalties may be imposed for violations of the anti-kickback statute and for the failure to return known overpayments, among other things. 12
Prohibition on Employing or Contracting with Excluded Providers. The Social Security Act and federal regulations state that individuals or entities that have been convicted of a criminal offense related to the delivery of an item or service under the Medicare or Medicaid programs or that have been convicted, under state or federal law, of a criminal offense relating to neglect or abuse of residents in connection with the delivery of a healthcare item or service cannot participate in any federal health care programs, including Medicare and Medicaid. Additionally, individuals and entities convicted of fraud, that have had their licenses revoked or suspended, or that have failed to provide services of adequate quality also may be excluded from the Medicare and Medicaid programs. Federal regulations prohibit Medicare providers, including hospice programs, from submitting claims for items or services or their related costs if an excluded provider furnished those items or services. The OIG maintains a list of excluded persons and entities. Nonetheless, it is possible that Vitas might unknowingly bill for services provided by an excluded person or entity with whom it contracts. The penalty for contracting with an excluded provider may range from civil monetary penalties of $50,000 and damages of up to three times the amount of payment that was inappropriately received. Corporate Practice of Medicine and Fee Splitting. Most states have laws that restrict or prohibit anyone other than a licensed physician, including business entities such as corporations, from employing physicians and/or prohibit payments or fee-splitting arrangements between physicians and corporations or unlicensed individuals. Penalties for violations of corporate practice of medicine and fee-splitting laws vary from state to state, but may include civil or criminal penalties, the restructuring or termination of the business arrangements between the physician and unlicensed individual or business entity, or even the loss of the physician's license to practice medicine. These laws vary widely from state to state both in scope and origin (e.g. statute, regulation, Attorney General opinion, court ruling, agency policy) and in most instances have been subject to only limited interpretation by the courts or regulatory bodies. Vitas employs or contracts with physicians to provide medical direction and patient care services to its patients. Vitas has made efforts in those states where certain contracting or fee arrangements are restricted or prohibited to structure those arrangements in compliance with the applicable laws and regulations. Despite these efforts, however, the Company cannot assure that agency officials charged with enforcing these laws will not interpret Vitas' contracts with employed or independent contractor physicians as violating the relevant laws or regulations. Future determinations or interpretations by individual states with corporate practice of medicine or fee splitting restrictions may force Vitas to restructure its arrangements with physicians in those locations. Health Information Practices. There currently are numerous legislative and regulatory initiatives at both the state and federal levels that address patient privacy concerns. In particular, federal regulations issued under the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") require Vitas to protect the privacy and security of patients' individual health information. HHS published final regulations addressing patient privacy on December 28, 2000, which were modified on August 14, 2002 (the "Privacy Rule"). Vitas was required to comply with the Privacy Rule by April 14, 2003, and Vitas believes that it is in material compliance. Additionally, HIPAA does not automatically preempt applicable state laws and regulations concerning Vitas' use, disclosure and maintenance of patient health information, which means that Vitas is subject to a complex regulatory scheme that, in many instances, requires Vitas to comply with both federal and state laws and regulations. In August 2000, HHS published final regulations establishing health care transaction standards and code sets for the electronic transmission of health care information in connection with certain transactions, such as billing or health plan eligibility (the "Transactions Standard"). The official deadline for compliance with the Transactions Standard for covered entities such as Vitas was October 16, 2003. The Centers for Medicare and Medicaid Services ("CMS") is the division of HHS that is responsible for interpreting and enforcing the Transactions Standard. Failure to comply with the Transactions Standard may subject covered entities, including Vitas, to civil monetary penalties and possibly to criminal penalties. Vitas believes that it has made 13
significant and appropriate good faith efforts to comply with the Transactions Standard and to develop an appropriate contingency plan as encouraged by CMS. It is unclear, however, how CMS will regulate providers in general or Vitas in particular with respect to compliance with the Transactions Standard. Consequently, it also is unclear whether Vitas would be found to be in material compliance with the Transactions Standard if CMS were to review Vitas' electronic claims submissions and assess Vitas' electronic transactions, or whether Vitas would be required to expend substantial sums on acquiring and implementing new information systems, or would otherwise be affected in a manner that would negatively impact its profitability. On May 31, 2002, HHS published its final rule regarding the HIPAA Unique Employer Identifier Standard, which establishes a standard for identifying employers in healthcare transactions where information about the employer is transmitted electronically, as well as requirements concerning its use by HIPAA covered entities. The deadline for compliance with the Unique Employer Identifier Standard rule was July 30, 2004. Additionally, HHS published final regulations addressing the security of such health information on February 20, 2003 (the "Security Rule"), and Vitas was required to and did substantially, comply with the Security Rule by April 21, 2005. Also, HHS published its final rule adopting the HIPAA Standard Unique Health Identifier for health care providers on January 23, 2004, and Vitas' compliance deadline for that rule is May 23, 2007. Because compliance with the final rules regarding the HIPAA Unique Employer Identifier Standard and the Standard Unique Health Identifier is not yet required, the Company cannot predict the total financial or other impact of any of these final regulations on Vitas' operations, including any need for Vitas to expend financial resources on acquiring and implementing new information systems or any other negative impact on Vitas' profitability. Additional Federal and State Regulation. Federal and state governments also regulate various aspects of the hospice industry. In particular, Vitas' operations are subject to federal and state health regulatory laws covering professional services, the dispensing of drugs and certain types of hospice activities. Some of Vitas' employees are subject to state laws and regulations governing the ethics and professional practice of medicine, respiratory therapy, pharmacy and nursing. Compliance with Health Regulatory Laws. Vitas maintains an internal regulatory compliance review program and from time to time retains regulatory counsel for guidance on compliance matters. The Company cannot assure, however, that Vitas' practices, if reviewed, would be found to be in compliance with applicable health regulatory laws, as such laws ultimately may be interpreted, or that any non-compliance with such laws would not have a material adverse effect on Vitas. ENVIRONMENTAL MATTERS Roto-Rooter's operations are subject to various federal, state, and local laws and regulations regarding environmental matters and other aspects of the operation of a sewer and drain cleaning, HVAC and plumbing services business. For certain other activities, such as septic tank and grease trap pumping, Roto-Rooter is subject to state and local environmental health and sanitation regulations. At December 31, 2005, the Company's accrual for its estimated liability for potential environmental cleanup and related costs arising from the sale of DuBois Chemicals Inc. ("DuBois") amounted to $3.0 million. Of this balance, $1.1 million is included in other liabilities and $1.9 million is included in other current liabilities. The Company is contingently liable for additional DuBois-related environmental cleanup and related costs up to a maximum of $15,999,000. On the basis of a continuing evaluation of the Company's potential liability, and in consultation with the Company's environmental attorney, management believes that it is not probable this additional liability will be paid. Accordingly, no provision for this contingent liability has been recorded. Although it is not presently possible to reliably project the timing of payments related to the Company's potential liability for environmental costs, management believes that any adjustments to its recorded liability will not materially adversely affect its financial position or results of operations. 14
The Company, to the best of its knowledge, is currently in compliance in all material respects with the environmental laws and regulations affecting its operations. Such environmental laws, regulations and enforcement proceedings have not required the Company to make material increases in or modifications to its capital expenditures and they have not had a material adverse effect on sales or net income. Capital expenditures for the purposes of complying with environmental laws and regulations during 2006 and 2007 with respect to continuing operations are not expected to be material in amount; there can be no assurance, however, that presently unforeseen legislative or enforcement actions will not require additional expenditures. SEASONALITY Advertising costs for Roto-Rooter inordinately impact the Company's fourth-quarter results. Roto-Rooter recognizes telephone directory costs immediately upon distribution of a directory by its publisher into the community. Since a large number of directories are distributed in the fourth quarter, this direct expense accounting policy results in fourth-quarter earnings including a disproportionately large share of Roto-Rooter's full-year telephone directory advertising expense. In the fourth quarter 2005, Roto-Rooter expensed $6.3 million of total advertising costs that represented 33.5% of the aggregate advertising costs for the full-year 2005. EMPLOYEES On December 31, 2005, Chemed Corporation had a total of 10,881 employees. AVAILABLE INFORMATION The Company's Internet address is www.chemed.com. The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are electronically available through the SEC (http://www.sec.gov) or the Company's website as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. Annual reports, press releases, Board Committee charters, Code of Ethics, Corporate governance guidelines and other printed materials may be obtained from the website or from Chemed Investor Relations without charge by writing to 2600 Chemed Center, 255 East Fifth Street, Cincinnati, Ohio 45202 or by calling 800-2CHEMED or 513-762-6429. ITEM 1A. RISK FACTORS You should carefully consider the risks described below. They are not the only ones facing the Company. Other risks and uncertainties not currently known to us or that we deem to be immaterial may also materially and adversely affect our business, financial condition, or results of operations. GENERAL WE HAVE INCURRED DEBT TO FINANCE THE OPERATIONS OF THE COMPANY. OUR LEVERAGE WILL LIMIT CASH FLOW AVAILABLE FOR OUR OPERATIONS, COULD ADVERSELY AFFECT OUR ABILITY TO SERVICE OUR DEBT OR OBTAIN ADDITIONAL FINANCING AND COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH AND OUR ABILITY TO REACT TO CHANGES IN OUR BUSINESS. The Company has debt service obligations that may restrict our operating flexibility. We cannot assure you that our cash flow from operations will be sufficient to service our debt, which may require us to borrow additional funds, or restructure or otherwise refinance our debt. In addition, the Company has the ability to expand its debt and borrowing capacity subject to various restrictions and covenants defined by its 15
creditors. The interest rate the Company pays will fluctuate from time to time based upon a number of factors including current LIBOR rates and Company operating performance. Significant changes in these factors could result in a material change in the Company's interest expense. Our indebtedness could have important consequences for our business. Among other things, our indebtedness may: - limit our ability to obtain additional financing; - limit our flexibility in planning for, or reacting to, changes in the markets in which we compete; - place us at a competitive disadvantage relative to our competitors with less indebtedness; - increase our exposure to interest rate increases due to variable interest rates on certain borrowings; - limit our ability to complete future acquisitions; - limit our ability to make capital expenditures; - render us more vulnerable to general adverse economic and industry conditions; and - require us to dedicate a substantial portion of our cash flow to service and repay our debt. Servicing our indebtedness will require a significant amount of cash, and our ability to generate cash depends on many factors beyond our control. Our ability to repay or to refinance our indebtedness and to pay interest on our indebtedness will depend on our operating performance, which may be affected by factors beyond our control. These factors could include operating difficulties, increased operating costs, our competitors' actions and regulatory developments. Our ability to meet our debt service and other obligations may depend in significant part on the extent to which we successfully implement our business strategy. We cannot assure you that we will be able to implement our strategy fully or that the anticipated results of our strategy will be realized. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional equity capital or restructure our debt. We cannot assure you that our cash flows and capital resources will be sufficient to make scheduled payments of principal and interest on our indebtedness in the future or that alternative measures would successfully meet our debt service obligations. As certain of our obligations under our credit facilities and certain other borrowings bear interest at floating rates, an increase in interest rates could further increase our debt service costs and adversely affect our cash flows. THE AGREEMENTS AND INSTRUMENTS GOVERNING OUR OUTSTANDING DEBT CONTAIN RESTRICTIONS AND LIMITATIONS THAT COULD SIGNIFICANTLY IMPACT OUR ABILITY TO OPERATE OUR BUSINESS AND ADVERSELY AFFECT THE PRICE OF OUR CAPITAL STOCK. The operating and financial restrictions and covenants in our instruments of indebtedness restrict our ability to: - incur additional debt; 16
- pay dividends, make redemptions and purchases of Capital Stock and make other restricted payments; - issue and sell capital stock of subsidiaries; - sell assets; - engage in transactions with affiliates; - restrict distributions from subsidiaries; - incur liens; - engage in businesses other than permitted businesses; - engage in sale/leaseback transactions; - engage in mergers or consolidations; - make capital expenditures; - make guarantees; - make investments and acquisitions; - enter into operating leases; - hedge interest rates; and - prepay other debt. Moreover, if we are unable to meet the terms of the financial covenants or if we breach any of these covenants, a default could result under one or more of these agreements. A default, if not waived by our lenders, could accelerate repayment of our outstanding indebtedness. If acceleration occurs, we may not be able to repay our debt and it is unlikely that we would be able to borrow sufficient additional funds to refinance such debt on acceptable terms. In the event of any default under our credit facilities, the lenders thereunder could elect to declare all outstanding borrowings, together with accrued and unpaid interest and other fees, to be due and payable, to require us to apply all of our available cash to repay these borrowings, any of which would be an event of default. WE DEPEND ON OUR MANAGEMENT TEAM AND THE LOSS OF THEIR SERVICE COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Our success depends to a large extent upon the continued services of our executive management team. The loss of key personnel could have a material adverse effect on our business, financial condition, results of operations and cash flows. Additionally, we cannot assure you that we will be able to attract or retain other skilled personnel in the future. ENVIRONMENTAL COMPLIANCE COSTS AND LIABILITIES COULD INCREASE OUR EXPENSES AND ADVERSELY AFFECT OUR FINANCIAL CONDITION. Our operations are subject to numerous environmental, health and safety laws and regulations that prohibit or restrict the discharge of pollutants into the environment and regulate employee exposure to hazardous substances in the workplace. Failure to comply with these laws could subject us to material costs and liabilities, including civil and criminal fines, costs to cleanup contamination we cause and, in some circumstances, costs to cleanup contamination we discover on our own property but did not cause. 17
Because we use and generate hazardous materials in some of our operations, we are potentially subject to material liabilities relating to the cleanup of contamination and personal injury claims. In addition, we have retained certain environmental liabilities in connection with the sale of former businesses. We are currently funding the cleanup of historical contamination at one of our former properties and contributing to the cleanup of third-party sites as a result of our sale of Dubois Chemicals Inc. Although we have established a reserve for these liabilities, actual cleanup costs may exceed our current estimates due to factors beyond our control, such as the discovery of additional contamination or the enforcement of more stringent cleanup requirements. New laws and regulations or their stricter enforcement, the discovery of presently unknown conditions or the receipt of additional claims for indemnification could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, financial condition and results of operations. WE ARE SUBJECT TO CERTAIN ANTI-TAKEOVER STATUES THAT MIGHT MAKE IT MORE DIFFICULT TO EFFECT A CHANGE IN CONTROL OF THE COMPANY. We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 could have the effect of delaying or preventing a change of control that could be advantageous to stockholders. AN ADVERSE RULING AGAINST US IN CERTAIN LITIGATION COULD HAVE AN ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We are involved in litigation incidental to the conduct of our business currently and from time to time. The damages claimed against us in some of these cases are substantial. See the "Legal Proceedings" section of this 10-K for discussion of particular matters. We cannot assure you that we will prevail in pending cases. Regardless of the outcome, such litigation is costly to manage, investigate and defend, and the related defense costs, diversion of management's time and related publicity may adversely affect the conduct of our business and the results of our operations. ROTO-ROOTER WE FACE INTENSE COMPETITION FROM NUMEROUS, FRAGMENTED COMPETITORS. IF WE DO NOT COMPETE EFFECTIVELY, OUR BUSINESS MAY SUFFER. We face intense competition from numerous competitors, many of whom have less leverage than we do. The sewer, drain and pipe cleaning, and plumbing repair businesses are highly fragmented, with the bulk of the industries consisting of local and regional competitors. We compete primarily on the basis of advertising, range of services provided, name recognition, speed and quality of customer service, service guarantees and pricing. Our competitors may succeed in developing new or enhanced products and services more successful than ours and in marketing and selling existing and new products and services better than us. In addition, new competitors may emerge. We cannot make any assurances that we will continue to be able to compete successfully with any of these companies. OUR OPERATIONS ARE SUBJECT TO NUMEROUS LAWS AND REGULATIONS, EXPOSING US TO POTENTIAL CLAIMS AND COMPLIANCE COSTS THAT COULD ADVERSELY AFFECT OUR BUSINESS. We are subject to federal, state and local laws and regulations relating to franchising, insurance and other aspects of our business. These are discussed in greater detail under "Government Regulations" in the Description of Business section hereof. If we fail to comply with existing or future laws and regulations, we may be 18
subject to governmental or judicial fines and sanctions. Our franchising activities are subject to various federal and state franchising laws and regulations, including the rules and regulations of the Federal Trade Commission (the "FTC") regarding the offering or sale of franchises. The rules and regulations of the FTC require us to provide all of our prospective franchisees with specific information regarding us and our franchise program in the form of a detailed franchise offering circular. In addition, a number of states require us to register our franchise offering prior to offering or selling franchises in such states. Various state laws also provide for certain rights in favor of franchisees, including (i) limitations on the franchisor's ability to terminate a franchise except for good cause, (ii) restrictions on the franchisor's ability to deny renewal of a franchise; (iii) circumstances under which the franchisor may be required to purchase certain inventory of franchisees when a franchise is terminated or not renewed in violation of such laws and (iv) provisions relating to arbitration. The ability to engage in the plumbing repair business is also subject to certain limitations and restrictions imposed by state and local licensing laws and regulations. We cannot predict what legislation or regulations affecting our business will be enacted in the future, how existing or future laws or regulations will be enforced, administered and interpreted, or the amount of future expenditures that may be required to comply with these laws or regulations. Compliance costs associated with governmental regulations could have material adverse effect on our business, financial condition and results of operations. VITAS VITAS IS HIGHLY DEPENDENT ON PAYMENTS FROM MEDICARE AND MEDICAID. IF THERE ARE CHANGES IN THE RATES OR METHODS GOVERNING THESE PAYMENTS, VITAS' NET PATIENT SERVICE REVENUE AND PROFITS COULD MATERIALLY DECLINE. Approximately 95% of Vitas' net patient service revenue consists of payments from the Medicare and Medicaid programs. Such payments are made primarily on a "per diem" basis, subject to annual reimbursement caps. Because Vitas receives a per diem fee to provide eligible services to all patients, Vitas' profitability is largely dependent upon its ability to manage the costs of providing hospice services to patients. Increases in operating costs, such as labor and supply costs that are subject to inflation, without a compensating increase in Medicare and Medicaid rates, could have a material adverse effect on Vitas' business in the future. Medicare and Medicaid currently adjust the various hospice payment rates annually based on the increase or decrease of the hospital wage index basket, regionally adjusted. However, the increases may be less than actual inflation. Vitas' profitability could be negatively impacted if this adjustment were eliminated or reduced, or if Vitas' costs of providing hospice services increased more than the annual adjustment. In addition, cost pressures resulting from shorter patient lengths of stay and the use of more expensive forms of palliative care, including drugs and drug delivery systems, could negatively impact Vitas' profitability. Many payors are increasing pressure to control health care costs. In addition, both public and private payors are increasing pressure to decrease, or limit increases in, reimbursement rates for health care services. Vitas' levels of revenues and profitability will be subject to the effect of possible reductions in coverage or payment rates by third-party payors, including payment rates from Medicare and Medicaid. Each state that maintains a Medicaid program has the option to provide reimbursement for hospice services at reimbursement rates generally required to be at least as much as Medicare rates. All states in which Vitas operates cover Medicaid hospice services; however, we cannot assure you that the states in which Vitas is presently operating or states into which Vitas could expand operations will continue to cover Medicaid hospice services. In addition, the Medicare and Medicaid programs are subject to statutory and regulatory changes, retroactive and prospective rate and payment adjustments, administrative rulings, freezes and funding reductions, all of which may adversely affect the level of program payments and could have a material adverse effect on Vitas' business. We cannot assure you that Medicare and /or Medicaid payments to hospices will not decrease. Reductions in amounts paid by government programs for services or changes in methods or regulations governing payments could cause Vitas' net patient service revenue and profits to materially decline. 19
APPROXIMATELY ONE-THIRD OF VITAS' HOSPICE PATIENTS RESIDE IN NURSING HOMES. CHANGES IN THE LAWS AND REGULATIONS REGARDING PAYMENTS FOR HOSPICE SERVICES AND "ROOM AND BOARD" PROVIDED TO VITAS' HOSPICE PATIENTS RESIDING IN NURSING HOMES COULD REDUCE ITS NET PATIENT SERVICE REVENUE AND PROFITABILITY. For Vitas' hospice patients receiving nursing home care under certain state Medicaid programs who elect hospice care under Medicare and Medicaid, the state generally must pay Vitas, in addition to the applicable Medicare or Medicaid hospice per diem rate, an amount equal to at least 95% of the Medicaid per diem nursing home rate for "room and board" furnished to the patient by the nursing home. Vitas contracts with various nursing homes for the nursing homes' provision of certain "room and board" services that the nursing homes would otherwise provide Medicaid nursing home patients. Vitas bills and collects from the applicable state Medicaid program an amount equal to approximately 95% of the amount that would otherwise have been paid directly to the nursing home under the state's Medicaid plan. Under Vitas' standard nursing home contracts, it pays the nursing home for these "room and board" services at approximately 100% of the Medicaid per diem nursing home rate. The reduction or elimination of Medicare and Medicaid payments for hospice patients residing in nursing homes would reduce Vitas' net patient service revenue and profitability. In addition, changes in the way nursing homes are reimbursed for "room and board" services provided to hospice patients residing in nursing homes could effect Vitas' ability to serve patients in nursing homes. IF VITAS IS UNABLE TO MAINTAIN RELATIONSHIPS WITH EXISTING PATIENT REFERRAL SOURCES OR TO ESTABLISH NEW REFERRAL SOURCES, VITAS' GROWTH AND PROFITABILITY COULD BE ADVERSELY AFFECTED. Vitas' success is heavily dependent on referrals from physicians, long-term care facilities, hospitals and other institutional health care providers, managed care companies, insurance companies and other patient referral sources in the communities that its hospice locations serve, as well as on its ability to maintain good relations with these referral sources. Vitas' referral sources may refer their patients to other hospice care providers or not to a hospice provider at all. Vitas' growth and profitability depend significantly on its ability to establish and maintain close working relationships with these patient referral sources and to increase awareness and acceptance of hospice care by its referral sources and their patients. We cannot assure you that Vitas will be able to maintain its existing relationships or that it will be able to develop and maintain new relationships in existing or new markets. Vitas' loss of existing relationships or its failure to develop new relationships could adversely affect its ability to expand or maintain its operations and operate profitably. Moreover, we cannot assure you that awareness or acceptance of hospice care will increase or remain at current levels. VITAS OPERATES IN AN INDUSTRY THAT IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION AND CLAIMS REVIEWS, AND CHANGES IN LAW AND REGULATORY INTERPRETATIONS COULD REDUCE ITS NET PATIENT SERVICE REVENUE AND PROFITABILITY AND ADVERSELY AFFECT ITS FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The health care industry is subject to extensive federal, state and local laws, rules and regulations relating to, among others: - payment for services; - conduct of operations, including fraud and abuse, anti-kickback prohibitions, self-referral prohibitions and false claims; - privacy and security of medical records; - employment practices; and 20
- various state approval requirements, such as facility and professional licensure, certificate of need, compliance surveys and other certification or recertification requirements. Changes in these laws, rules and regulations or in interpretations thereof could reduce Vitas' net patient service revenue and profitability. See the "Government Regulations" section of this 10-K for a greater description of these matters. Fraud and Abuse Laws. Vitas contracts with a significant number of health care providers and practitioners, including physicians, hospitals and nursing homes and arranges for these entities to provide services to Vitas' patients. Some of these health care providers and practitioners may refer, or be in a position to refer, patients to Vitas (or Vitas may refer patients to them). These arrangements may not qualify for a safe harbor. Vitas from time to time seeks guidance from regulatory counsel as to the changing and evolving interpretations and the potential applicability of the Anti-Kickback Law to its programs, and in response thereto, takes such actions as it deems appropriate. Vitas generally believes that its contracts and arrangements with providers, practitioners and suppliers should not be found to violate the Anti-Kickback Law. However, we cannot assure you that such laws will ultimately be interpreted in a manner consistent with Vitas' practices. Several health care reform proposals have included an expansion of the Anti-Kickback Law to include referrals of any patients regardless of payor source, which is similar to the scope of certain laws that have been enacted at the state level. In addition, a number of states in which Vitas operates have laws, which vary from state to state, prohibiting certain direct or indirect remuneration or fee-splitting arrangements between health care providers, regardless of payor source, for the referral of patients to a particular provider. The federal Ethics in Patient Referral Act, Section 1877 of the Social Security Act (commonly know an the "Stark Law") prohibits physicians from referring Medicare or Medicaid patients for "designated health services" to entities in which they hold an ownership or investment interest or with whom they have a compensation arrangement, subject to certain statutory or regulatory exceptions. We cannot assure you that future statutory or regulatory changes will not result in hospice services being subject to the Stark Law's ownership, investment, compensation or referral prohibitions. Several states in which Vitas operates have similar laws which likewise are subject to change. Any such changes could adversely affect the business, financial condition and operating results of Vitas. Further, under separate statutes, submission of claims for items or services that are "not provided as claimed" may lead to civil money penalties, criminal fines and imprisonment and/or exclusion from participation in Medicare, Medicaid and other federally funded state health care programs. These false claims statutes include the federal False Claims Act, which allows any person to bring suit on behalf of the federal government, known as a qui tam action, alleging false or fraudulent Medicare or Medicaid claims or other violations of the statute and to share in any amounts paid by the entity to the government in fines or settlement. Any entity found to be violating the False Claims Act may be liable for up to $11,000 per false claim and treble the amount of damages the federal government is found to have sustained because of the false claims. Certificate of Need Laws. Many states, including Florida, have certificate of need laws or other similar health planning laws that apply to hospice care providers. These states may require some form of state agency review or approval prior to opening a new hospice program, to adding or expanding hospice services, to undertaking significant capital expenditures or under other specified circumstances. Approval under these certificate of need laws is generally conditioned on the showing of a demonstrable need for services in the community. Vitas may seek to develop, acquire or expand hospice programs in states having certificate of need laws. To the extent that state agencies require Vitas to obtain a certificate of need or other similar approvals to expand services at existing hospice programs or to make acquisitions or develop hospice programs in new or existing geographical markets, Vitas' plans could be adversely affected by a failure to obtain a certificate or approval. In addition, competitors may seek administratively or judicially to challenge such an approval or proposed approval 21
by the state agency, and Vitas has been defending against such a challenge in connection with the development of its Palm Beach County, Florida hospice program. Such a challenge, whether or not ultimately successful, could adversely affect Vitas. Other Federal and State Regulations. The federal government and all states regulate various aspects of the hospice industry and Vitas' business. In particular, Vitas' operations are subject to federal and state health regulatory laws, including those covering professional services, the dispensing of drugs and certain types of hospice activities. Certain of Vitas' employees are subject to state laws and regulations governing professional practice. Vitas' operations are subject to periodic survey by governmental authorities and private accrediting entities to assure compliance with applicable state licensing, and Medicare and Medicaid certification and accreditation standards, as the case may be. From time to time in the ordinary course of business, Vitas receives survey reports noting deficiencies for alleged failure to comply with applicable requirements. Vitas reviews such reports and takes appropriate corrective action. The failure to effect such action could result in one of Vitas' hospice programs being terminated from the Medicare hospice program. Any termination of one or more of Vitas' hospice locations from the Medicare hospice program could adversely affect Vitas' net patient service revenue and profitability and adversely affect its financial condition and results of operations. The failure to obtain, renew or maintain any of the required regulatory approvals, certifications or licenses could materially adversely affect Vitas' business and could prevent the programs involved from offering products and services to patients. In addition, laws and regulations often are adopted to regulate new products, services and industries. We cannot assure you that either the states or the federal government will not impose additional regulations on Vitas' activities, which might materially adversely affect Vitas. Claims Review. The Medicare and Medicaid programs and their fiscal intermediaries and other payors periodically conduct pre-payment or post-payment reviews and other reviews and audits of health care claims, including hospice claims. As a result of such reviews or audits, Vitas could be required to return any amounts found to be overpaid, or amounts found to be overpaid could be recouped through reductions in future payments. There is pressure from state and federal governments and other payors to scrutinize health care claims to determine their validity and appropriateness. During the past several years, Vitas' claims have been subject to review and audit. We cannot assure you that reviews and/or similar audits of Vitas' claims will not result in material recoupments, denials or other actions that could have a material adverse effect on Vitas' business, financial condition and results of operations. See the discussion of OIG investigation pending against Vitas under Other Health Care Regulations, above. Regulation and Provision of Continuous Home Care. Vitas provides continuous home care to patients requiring such care. Continuous home care is provided to patients while at home, during periods of crisis when intensive monitoring and care, primarily nursing care, is required in order to achieve palliation or management of acute medical symptoms. Continuous home care requires a minimum of 8 hours of care within a 24-hour day, which begins and ends at midnight. The care must be predominantly nursing care provided by either a registered nurse or licensed practical nurse. Continuous home care can be challenging for a hospice to provide for a number of reasons, including the need to have available sufficient skilled and trained staff to furnish such care, the need to manage the staffing and provision of such care, and a shortage of nurses that can make it particularly difficult to attract and retain nurses that are required to furnish a majority of such care. Medicare reimbursement for continuous home care is calculated by multiplying the applicable continuous home care hourly rate by the number of hours of care provided. Medicare reimbursement for continuous home care is subject to a number of requirements posing further challenges for a hospice providing such care. For example, if a patient requires skilled interventions for palliation or symptom management that can be accomplished in less than 8 aggregate hours within the 24-hour period, if the majority of care can be accomplished by someone other than a registered nurse or a licensed practical nurse (e.g., if a majority of care is furnished by a home health aide or homemaker), or if for any reason less than 8 hours of direct care are provided (such as when a patient dies before 8 AM even if 7 or more hours of care has been provided), 22
the care rendered cannot be reimbursed by Medicare at the continuous home care rate (although the care instead may be eligible for Medicare reimbursement at the reduced routine home care day rate). As a result of such requirements, Vitas may incur the costs of providing services intended to be continuous home care services yet be unable to bill or be reimbursed for such services at the continuous home care rate. We cannot assure you that challenges in providing continuous home care will not cause Vitas' net patient service revenue and profits to materially decline or that reviews and/or similar audits of Vitas' claims will not result in material recoupments, denials or other actions that could have a material adverse effect on Vitas' business, financial condition and results of operations. Compliance. Vitas maintains an internal regulatory compliance review program and from time to time retains regulatory counsel for guidance on compliance matters. We cannot assure you, however, that Vitas' practices, if reviewed, would be found to be in compliance with applicable health regulatory laws, as such laws ultimately may be interpreted, or that any non-compliance with such laws would not have a material adverse effect on Vitas. FEDERAL AND STATE LEGISLATIVE AND REGULATORY INITIATIVES RELATING TO PATIENT PRIVACY COULD REQUIRE VITAS TO EXPEND SUBSTANTIAL SUMS ON ACQUIRING, IMPLEMENTING AND SUPPORTING NEW INFORMATION SYSTEMS, WHICH COULD NEGATIVELY IMPACT ITS PROFITABILITY. There are currently numerous legislative and regulatory initiatives at both the state and federal levels that address patient privacy concerns. In particular, regulations issued under the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") require Vitas to protect the privacy and security of patients' individual health information. We cannot predict the total financial or other impact of the regulations on Vitas' operations. In addition, although Vitas' management believes it is in compliance with the requirement of patient privacy regulations, we cannot assure you that Vitas will not be found to have violated state and federal laws, rules or guidelines surrounding patient privacy. Compliance with current and future HIPAA requirements or any other federal or state privacy initiatives could require Vitas to make substantial investments, which could negatively impact its profitability and cash flows. VITAS' GROWTH STRATEGIES MAY NOT BE SUCCESSFUL, WHICH COULD ADVERSELY AFFECT ITS BUSINESS. A significant element of Vitas' growth strategy is expected to include expansion of its business by developing new hospice locations in new and existing markets. This aspect of Vitas' growth strategy may not be successful, which could adversely impact its growth and profitability. We cannot assure you that Vitas will be able to: - identify markets that meet its selection criteria for new hospice locations; - hire and retain qualified management teams to operate each of its new hospice locations; - manage a large and geographically diverse group of hospice locations; - become Medicare and Medicaid certified in new markets; - generate sufficient hospice admissions in new markets to operate profitably in these new markets; - compete effectively with existing hospices in new markets; or - obtain state licensure and/or a certificate of need from appropriate state agencies in new markets. In addition to growing existing locations and developing new hospice locations, Vitas' growth strategy is expected to include expansion through acquisition of other 23
hospices. We cannot assure you that Vitas' acquisition strategy will be successful. The success of Vitas' acquisition strategy depends upon a number of factors, including: - its ability to identify suitable acquisition candidates; - its ability to negotiate favorable acquisition terms, including purchase price, which may be adversely affected due to increased competition with other buyers; - the availability of financing on favorable terms, or at all; - its ability to integrate effectively the systems and operations of acquired hospices; - its ability to retain key personnel of acquired hospices; and - its ability to obtain required regulatory approvals. Acquisitions involve a number of other risks, including diversion of management's attention from other business concerns and assuming known or unknown liabilities of acquired hospices, including liabilities for failure to comply with health care laws and regulations. Integrating acquired hospices may place significant strains on Vitas' current operating and financial systems and controls. Vitas may not successfully overcome these risks or any other problems encountered in connection with its acquisition strategy. In addition, since 1990, Vitas has acquired hospice programs, some of which involved acquisitions of hospice programs from not-for-profit entities. Vitas believes that acquisitions of not-for-profit programs are generally more complex than acquisitions from for-profit entities and that a substantial number of acquisition opportunities are likely to involve acquisitions from not-for-profit entities. Such acquisitions are subject to provisions of the Internal Revenue Code and, in certain states, state attorney general powers, which have been interpreted to require that the consideration paid for the assets purchased be at fair market value and, where applicable, that any fees paid for services be reasonable. In many states there is no mechanism for state attorney general pre-clearance of transactions to assure that applicable standards have been met. Entities that acquire not-for-profit hospices could face potential liability if the acquisition transaction is not structured to comply with Internal Revenue Code and state law requirements, and in some cases the transaction could be enjoined or subject to rescission. The acquisition of not-for-profit businesses, including the fairness of the purchase price paid, has received increasing regulatory scrutiny by state attorneys general and other regulatory authorities. Although Vitas believes that reasonable actions have been taken to date to establish the fair market value of assets purchased in prior acquisitions of hospice operations from not-for-profit entities and the reasonableness of fees paid for services, we cannot assure you that such transactions or any future similar transactions will not be challenged or that, if challenged, the results of such challenge would not have a material adverse effect on Vitas' business. VITAS' LOSS OF KEY MANAGEMENT PERSONNEL OR ITS INABILITY TO HIRE AND RETAIN SKILLED EMPLOYEES COULD ADVERSELY AFFECT ITS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Vitas' future success significantly depends upon the continued service of its senior management personnel. The loss of one or more of Vitas' key senior management personnel or its inability to hire and retain new skilled employees could negatively impact Vitas' ability to maintain or increase patient referrals, a key aspect of its growth strategy, and could adversely affect its future operating results. Competition for skilled employees is intense, and the process of locating and recruiting skilled employees with the combination of qualifications and attributes required to care effectively for terminally ill patients and their families can be difficult and lengthy. We cannot assure you that Vitas will be successful in 24
attracting, retaining or training highly skilled nursing, management, community education, operations, admissions and other personnel. Vitas' business could be disrupted and its growth and profitability negatively impacted if it is unable to attract and retain skilled employees. A NATIONWIDE SHORTAGE OF QUALIFIED NURSES COULD ADVERSELY AFFECT VITAS' PROFITABILITY, GROWTH AND ABILITY TO CONTINUE TO PROVIDE QUALITY, RESPONSIVE HOSPICE SERVICES TO ITS PATIENTS AS NURSING WAGES AND BENEFITS INCREASE. The substantial majority of Vitas' workforce is nurses. Vitas depends on qualified nurses to provide quality, responsive hospice services to its patients. The current nationwide shortage of qualified nurses impacts some of the markets in which Vitas provides hospice services. In response to this shortage, Vitas has adjusted its wages and benefits to recruit and retain nurses and to engage contract nurses. Vitas' inability to attract and retain qualified nurses could adversely affect its ability to provide quality, responsive hospice services to its patients and its ability to increase or maintain patient census in those markets. Increases in the wages and benefits required to attract and retain qualified nurses or an increase in reliance on contract nurses could negatively impact profitability. VITAS MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST OTHER HOSPICE PROVIDERS, AND COMPETITIVE PRESSURES MAY LIMIT ITS ABILITY TO MAINTAIN OR INCREASE ITS MARKET POSITION AND ADVERSELY AFFECT ITS PROFITABILITY, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Hospice care in the United States is highly competitive. In many areas in which Vitas' hospices are located, they compete with a large number of organizations, including: - community-based hospice providers; - national and regional companies; - hospital-based hospice and palliative care programs; - physician groups; - nursing homes; - home health agencies; - infusion therapy companies; and - nursing agencies Various health care companies have diversified into the hospice market. Other companies, including hospitals and health care organizations that are not currently providing hospice care, may enter the markets Vitas serves and expand the variety of services offered to include hospice care. We cannot assure you that Vitas will not encounter increased competition in the future that could limit its ability to maintain or increase its market position, including competition from parties in a position to impact referrals to Vitas. Such increased competition could have a material adverse effect on Vitas' business, financial condition and results of operations. CHANGES IN RATES OR METHODS OF PAYMENT FOR VITAS' SERVICES COULD ADVERSELY AFFECT ITS REVENUES AND PROFITS. Managed care organizations have grown substantially in terms of the percentage of the population that is covered by such organizations and in terms of their control over an increasing portion of the health care economy. Managed care organizations have continued to consolidate to enhance their ability to influence the delivery of health care services and to exert pressure to control health care costs. Vitas has a number of contractual arrangements with managed care organizations and other similar parties. 25
Vitas provides hospice care to many Medicare beneficiaries who receive their non-hospice health care services from health maintenance organizations ("HMOs") under Medicare risk contracts. Under such contracts between HMOs and the federal Department of Health and Human Services, the Medicare payments for hospice services are excluded from the per-member, per-month payment from Medicare to HMOs and instead are paid directly by Medicare to the hospices. As a result, Vitas' payments for Medicare beneficiaries enrolled in Medicare risk HMOs are processed in the same way with the same rates as other Medicare beneficiaries. We cannot assure, however, that payment for hospice services will continue to be excluded from HMO payment under Medicare risk contracts and similar Medicare managed care plans or that if not excluded, managed care organizations or other large third-party payors would not use their power to influence and exert pressure on health care providers to reduce costs in a manner that could have a material adverse effect on Vitas' business, financial condition and results of operations. LIABILITY CLAIMS MAY HAVE AN ADVERSE EFFECT ON VITAS, AND ITS INSURANCE COVERAGE MAY BE INADEQUATE. Participants in the hospice industry are subject to lawsuits alleging negligence, product liability or other similar legal theories, many of which involve large claims and significant defense costs. From time to time, Vitas is subject to such and other types of lawsuits. See the description below under Legal Proceedings. The ultimate liability for claims, if any, could have a material adverse effect on its financial condition or operating results. Although Vitas currently maintains liability insurance intended to cover the claims, we cannot assure you that the coverage limits of such insurance policies will be adequate or that all such claims will be covered by the insurance. In addition, Vitas' insurance policies must be renewed annually and may be subject to cancellation during the policy period. While Vitas has been able to obtain liability insurance in the past, such insurance varies in cost, is difficult to obtain and may not be available in the future on terms acceptable to Vitas, if at all. A successful claim in excess of the insurance coverage could have a material adverse effect on Vitas. Claims, regardless of their merit or eventual outcome, also may have a material adverse effect on Vitas' business and reputation due to the costs of litigation, diversion of management's time and related publicity. Vitas procures professional liability coverage on a claims-made basis. The insurance contracts specify that coverage is available only during the term of each insurance contract. Vitas' management intends to renew or replace the existing claims-made policy annually but such coverage is difficult to obtain, may be subject to cancellation and may be written by carriers that are unable, or unwilling to pay claims. During fiscal 2001, Vitas was notified that one of its prior carriers was ordered into rehabilitation, and in early fiscal 2002, into liquidation, creating the possibility that certain prior year claims could be underinsured or uninsured. Certain claims have been asserted where the coverage would be the responsibility of this prior carrier and/or other carriers that may not have the financial wherewithal to satisfy the claims. Additionally, some risks and liabilities, including claims for punitive damages, are not covered by insurance. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES The Company's corporate offices and the headquarters for the Roto-Rooter Group are located in Cincinnati, Ohio. Roto-Rooter has manufacturing and distribution center facilities in West Des Moines, Iowa and has 72 office and service facilities in 26 states. Vitas, headquartered in Miami, operates 39 programs from 69 leased facilities in 15 states. 26
All "owned" property is held in fee and is subject to the security interests of the holders of our debt instruments issued in connection with the Company's merger with Vitas. The leased properties have lease terms ranging from one year to fourteen years. Management does not foresee any difficulty in renewing or replacing the remainder of its current leases. The Company considers all of its major operating properties to be maintained in good operating condition and to be generally adequate for present and anticipated needs. ITEM 3. LEGAL PROCEEDINGS The Company is party to a class action lawsuit filed in the Third Judicial Circuit Court of Madison County, Illinois in June of 2000 by Robert Harris, alleging certain Roto-Rooter plumbing was performed by unlicensed employees. The Company contests these allegations and believes them without merit. Plaintiff moved for certification of a class of customers in 32 states who allegedly paid for plumbing work performed by unlicensed employees. Plaintiff also moved for partial summary judgment on grounds the licensed apprentice plumber who installed his faucet did not work under the direct personal supervision of a licensed master plumber. On June 19, 2002, the trial judge certified an Illinois-only plaintiffs class and granted summary judgment for the named party Plaintiff on the issue of liability, finding violation of the Illinois Plumbing License Act and the Illinois Consumer Fraud Act, through Roto-Rooter's representation of the licensed apprentice as a plumber. The court has not ruled on certification of a class in the remaining 31 states. In December 2004, the Company reached a resolution of this matter with the plaintiff. This proposed settlement has been preliminarily approved by the court. We expect the parties to request final approval later in 2006. We have accrued $3.1 million as the anticipated cost of settling this litigation. Vitas Healthcare Corporation is party to a class action lawsuit filed in the Superior Court of California, Los Angeles County, in April of 2004 by Ann Marie Costa, Ana Jimenez, Mariea Ruteaya and Gracetta Wilson alleging failure to pay overtime wages and to provide meal and break periods to California nurses, home health aides and licensed clinical social workers. The Company contests these allegations and believes them without merit. Plaintiffs moved for class certification, and Vitas opposed this motion. We have reached an agreement, subject to court approval, with the Plaintiff class to resolve this matter for $19 million, inclusive of Plaintiffs' class attorneys' fees and the costs of settlement administration. Regardless of outcome, such litigation can adversely affect the Company through defense costs, diversion of management's time, and related publicity. See also the OIG investigation pending against Vitas under Other Health Care Regulations, above. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. EXECUTIVE OFFICERS OF THE COMPANY Name Age Office First Elected - -------------------- --- ------------------------------------------ ------------------ Kevin J. McNamara 52 President and Chief Executive Officer August 2, 1994 (1) Timothy S. O'Toole 50 Executive Vice President May 18, 1992 (2) Spencer S. Lee 50 Executive Vice President May 15, 2000 (3) David P. Williams 45 Vice President and Chief Financial Officer March 5, 2004 (4) Arthur V. Tucker,Jr. 56 Vice President and Controller May 20, 1991 (5) (1) Mr. K. J. McNamara is President and Chief Executive Officer of the Company and has held these positions since August 1994 and May 2001, respectively. Previously, he 27
served as an Executive Vice President, Secretary and General Counsel of the Company, since November 1993, August 1986 and August 1986, respectively. He previously held the position of Vice President of the Company, from August 1986 to May 1992. (2) Mr. T. S. O'Toole is an Executive Vice President of the Company and has held this position since May 1992. He is also Chief Executive Officer of Vitas, a wholly owned subsidiary of the Company, and has held this position since February 24, 2004. Previously, from May 1992 to February 24, 2004, he also served the Company as Treasurer. (3) Mr. S. S. Lee is an Executive Vice President of the Company and has held this position since May 15, 2000. Mr. Lee is also Chairman and Chief Executive Officer of Roto-Rooter Services Company, a wholly owned subsidiary of the Company, and has held this position since January 1999. Previously, he served as a Senior Vice President of Roto-Rooter Services Company from May 1997 to January 1999. (4) Mr. D. P. Williams is Vice President and Chief Financial Officer of the Company and has held these positions since March 5, 2004. Mr. Williams is also Senior Vice President and Chief Financial Officer of Roto-Rooter Group, Inc. and has held these positions since January 1999. (5) Mr. A. V. Tucker, Jr. is a Vice President and Controller of the Company and has held these positions since February 1989. From May 1983 to February 1989, he held the position of Assistant Controller of the Company. Each executive officer holds office until the annual election at the next annual organizational meeting of the Board of Directors of the Company which is scheduled to be held on May 15, 2006. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The Company's Capital Stock (par value $1 per share) is traded on the New York Stock Exchange under the symbol CHE. The range of the high and low sale prices on the New York Stock Exchange and dividends paid per share for each quarter of 2004 and 2005 adjusted for a 2-for-1 stock split occurring May 11, 2005, are set forth below. Closing -------------------------------- Dividends Paid High Low Per Share ------ ------ -------------- 2004 First Quarter $33.48 $24.48 $.06 Second Quarter 27.65 21.55 .06 Third Quarter 28.13 21.36 .06 Fourth Quarter 33.72 27.56 .06 2005 First Quarter $38.63 $32.55 $.06 Second Quarter 43.83 34.57 .06 Third Quarter 44.90 39.32 .06 Fourth Quarter 54.00 40.13 .06 Future dividends are necessarily dependent upon the Company's earnings and financial condition, compliance with certain debt covenants and other factors not presently determinable. 28
As of March 1, 2006, there were approximately 3,158 stockholders of record of the Company's Capital Stock. This number only includes stockholders of record and does not include stockholders with shares beneficially held in nominee name or within clearinghouse positions of brokers, banks or other institutions. As of December 31, 2005, the number of stock options outstanding under the Company's equity compensation plans, the weighted average exercise price of outstanding options, and the number of securities remaining available for issuance were as follows: EQUITY COMPENSATION PLAN INFORMATION Number of securities remaining available for future issuance under Number of Securities to Weighted-average equity compensation be issued upon exercise exercise price of plans [excluding of outstanding warrants outstanding options, securities reflected in and rights warrants and rights column (a)] Plan Category (a) (b) (c) - ------------- ----------------------- -------------------- ------------------------------- Equity Compensation plans approved by stockholders 1,671,462 $23.70 137,035 Equity Compensation plans not approved by stockholders (1) 70,371 20.61 1,588 --------- ------ ------- TOTAL 1,741,833 23.57 138,623 --------- ------ ------- (1) In May 1999 the Board of Directors adopted the 1999 Long-Term Employee Incentive Plan without stockholder approval. This plan permits the Company to grant up to 500,000 shares of non-qualified options and stock awards to a broad base of salaried and hourly employees (excluding officers and directors) of the Company. Except for the exclusion of officers and directors, this plan has the same general terms and provisions as the 2004 Stock Incentive Plan. In addition, pursuant to this plan no individual may be granted more than 50,000 stock options in a calendar year, the aggregate number of the shares of Capital Stock which may be issued pursuant to stock incentives in the form of Stock Awards shall not be more than 270,000, and no stock incentives shall be granted under the plan after May 17, 2009. ITEM 6. SELECTED FINANCIAL DATA The information called for by this Item for the five years ended December 31, 2005 is set forth on page 40 of the 2005 Annual Report to Stockholders and is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 29
The information called for by this Item is set forth on pages 41 through 54 of the 2005 Annual Report to Stockholders and is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure relates to interest rate risk exposure through its variable interest rate borrowings. At December 31, 2005 the Company had a total of $84.4 million of variable rate debt outstanding. In February 2005, the Company called its Floating Rate Notes, restructured its revolving credit/ term loan agreement with JPMorgan Chase and reduced its variable rate debt to $88.5 million at February 28, 2005. Should the interest rate on this debt increase or decrease 100 basis points (1% point), the Company's annual interest expense would increase or decrease $844,000. The Company continually evaluates this interest rate exposure and periodically weighs the cost versus the benefit of fixing the variable interest rates through a variety of hedging techniques. The market value of the Company's long-term debt at December 31, 2005 is approximately $244.1 million versus a carrying value of $235.1 million. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements, together with the report thereon of PricewaterhouseCoopers LLP dated March 16, 2006, appearing on pages 5 through 37 of the 2005 Annual Report to Stockholders, along with the Supplementary Data (Unaudited Summary of Quarterly Results) appearing on pages 38-39, are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company's management, under the supervision of and with the participation of the Company's President and Chief Executive Officer, Vice President and Chief Financial Officer and Vice President and Controller, has evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report. Based on such evaluation, the Company's President and Chief Executive Officer, Vice President and Chief Financial Officer and Vice President and Controller have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective and are reasonably designed to ensure that all material information relating to the Company required to be included in the Company's reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to management, including the President and Chief Executive Officer, Vice President and Chief Financial Officer and Vice President and Controller, as appropriate, to allow timely decisions regarding required disclosure. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Refer to Management's Report on Internal Control over Financial Reporting and Report of Independent Registered Public Accounting Firm on pages 5 and 6 of the Company's 2005 Annual Report to Stockholders, which are incorporated herein by reference. 30
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There have not been any changes in the Company's internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act during the Company's fiscal quarter ended December 31, 2005 that have materially affected, or are reasonable likely to materially affect the Company's internal control over financial reporting. ITEM 9B. OTHER INFORMATION Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors of the Company are: Edward L. Hutton Kevin J. McNamara Donald Breen, Jr. Charles H. Erhart, Jr. Joel F. Gemunder Patrick P. Grace Thomas C. Hutton Walter L. Krebs Sandra E. Laney Timothy S. O'Toole Donald E. Saunders George J. Walsh III Frank E. Wood The additional information required under this Item with respect to the directors and executive officers is set forth in the Company's 2006 Proxy Statement and in Part I hereof under the caption "Executive Officers of the Registrant" and is incorporated herein by reference. The Company has adopted a Code of Ethics that applies to the Company's principal executive officer, principal financial officer, principal accounting officer, directors and employees. A copy of this Code of Ethics is incorporated with this Report as Exhibit 14 and it is also posted on the Company's Web site, www.chemed.com. ITEM 11. EXECUTIVE COMPENSATION Information required under this Item is set forth in the Company's 2006 Proxy Statement, which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required under this Item is set forth in the Company's 2006 Proxy Statement, which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required under this Item is set forth in the Company's 2006 Proxy Statement, which is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES AUDIT FEES 31
PricewaterhouseCoopers LLP billed the company $1,989,000 in 2004 and $1,485,000 in 2005. These fees were for professional services rendered for the integrated audit of the Company's annual financial statements and of its internal control over financial reporting, review of the financial statements included in the Company's Forms 10-Q and review of documents filed with the SEC. AUDIT-RELATED FEES PricewaterhouseCoopers LLP billed the company $1,446,000 and $189,000 in 2004 and 2005, respectively for audit-related services. In 2004, $1,115,000 of these fees related to audits of significant subsidiaries of the Company for years 2001, 2002, and 2003 financial statements for the purpose of registering the Company's floating rate notes, $205,000 for review of the Private Placement Memorandum related to the acquisition of VITAS, $59,000 for consultation concerning financial accounting and reporting standards and the remaining $67,000 was related primarily to the audit of the Company's employee benefit plans. In 2005, $75,000 was related to the audit of the employee benefit plans and $114,000 was related to audits of Vitas' Florida subsidiaries. TAX FEES No such services were rendered in 2004 or 2005. ALL OTHER FEES PricewaterhouseCoopers LLP billed the Company $2,300 and $2,400, respectively, in aggregate fees for services rendered by PricewaterhouseCoopers LLP, other than the services described above, for the years 2004 and 2005. The Audit Committee has adopted a policy which requires the Committee's pre-approval of audit and non-audit services performed by the independent auditor to assure that the provision of such services does not impair the auditor's independence. The Audit Committee pre-approved all of the audit and non-audit services rendered by PricewaterhouseCoopers LLP as listed above. 32
PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES EXHIBITS 3.1 Certificate of Incorporation of Chemed Corporation.* 3.2 Certificate of Amendment to Certificate of Incorporation.* 3.3 By-Laws of Chemed Corporation.* 4.1 Indenture, dated as of February 24, 2004, between Roto-Rooter, Inc. and LaSalle Bank National Association.* 4.2 Indenture, dated as of February 24, 2004, among Roto-Rooter, Inc., the subsidiary guarantors listed on Schedule I thereto and Wells Fargo Bank, N.A.* 10.1 Agreement and Plan of Merger among Diversey U.S. Holdings, Inc., D. C. Acquisition Inc., Chemed Corporation and DuBois Chemicals, Inc., dated as of February 25, 1991.* 10.2 Agreement and Plan of Merger among National Sanitary Supply Company, Unisource Worldwide, Inc. and TFBD, Inc. dated as of August 11, 1997.* 10.3 Stock Purchase Agreement dated as of May 8, 2002 by and between PCI Holding Corp. and Chemed Corporation. * 10.4 Amendment No. 1 to Stock Purchase Agreement dated as of October 11, 2002 by and among PCI Holding Corp., PCI-A Holding Corp. and Chemed Corporation. * 10.5 Senior Subordinated Promissory Note dated as of October 11, 2002 by and among PCI Holding Corp. and Chemed Corporation. * 10.6 Common Stock Purchase Warrant dated as of October 11, 2002 by and between PCI Holding Corp. and Chemed Corporation. * 10.7 1995 Stock Incentive Plan.*,** 10.8 1997 Stock Incentive Plan.*,** 10.9 1999 Stock Incentive Plan.*,** 10.10 1999 Long-Term Employee Incentive Plan as amended through May 20, 2002.*,** 10.11 2002 Stock Incentive Plan.*,** 10.12 2002 Executive Long-Term Incentive Plan, as amended May 18, 2004.*,** 10.13 2004 Stock Incentive Plan.*,** 10.14 Employment Contracts with Executives.*,** 10.15 Amendment to Employment Agreements with Kevin J. McNamara, Thomas C. Hutton and Sandra E. Laney dated August 7, 2002.*,** 10.16 Amendment to Employment Agreements with Timothy S. O'Toole and Arthur V. Tucker dated August 7, 2002.*,** 10.17 Amendment to Employment Agreement with Spencer S. Lee dated May 19, 2003.*,** 10.18 Amendment to Employment Agreements with Executives dated January 1, 2002.*,** 33
10.19 Amendment No. 16 to Employment Agreement with Sandra E. Laney dated March 1, 2003.*,** 10.20 Amendment No. 16 to Employment Agreement with Kevin J. McNamara dated May 18, 2004.*,** 10.21 Employment Agreement with David P. Williams dated May 16, 1994; Amendment dated May 21, 2001, and Amendment dated May 19, 2003.*,** 10.22 Excess Benefits Plan, as restated and amended, effective June 1, 2001.*,** 10.23 Amendment No. 1 to Excess Benefits Plan, effective July 1, 2002.*,** 10.24 Amendment No. 2 to Excess Benefits Plan, effective November 7, 2003.*,** 10.25 Non-Employee Directors' Deferred Compensation Plan.*,** 10.26 Chemed/Roto-Rooter Savings & Retirement Plan, effective January 1, 1999.*,** 10.27 First Amendment to Chemed/Roto-Rooter Savings & Retirement Plan, effective September 6, 2000.*,** 10.28 Second Amendment to Chemed/Roto-Rooter Savings & Retirement Plan, effective January 1, 2001.*,** 10.29 Third Amendment to Chemed/Roto-Rooter Savings & Retirement Plan, effective December 12, 2001.*,** 10.30 Directors Emeriti Plan.*,** 10.31 Second Amendment to Split Dollar Agreement with Executives.*,** 10.32 Split Dollar Agreement with Executives.*,** 10.33 Split Dollar Agreement with Edward L. Hutton.*,** 10.34 Promissory Note under the Executive Stock Purchase Plan with Kevin J. McNamara.*,** 10.35 Schedule to Promissory Note under the Executive Stock Purchase Plan with Kevin J. McNamara.** 10.36 Roto-Rooter Deferred Compensation Plan No. 1, as amended January 1,1998.*,** 10.37 Roto-Rooter Deferred Compensation Plan No. 2.*,** 10.38 Agreement and Plan of Merger, dated as of December 18, 2003, Among Roto-Rooter, Inc., Marlin Merger Corp. and Vitas Healthcare Corporation.* 10.39 Credit Agreement, dated as of February 24, 2004, among Roto-Rooter, Inc., the lenders from time to time parties thereto and Bank One, NA, as Administrative Agent.* 10.40 Amended and Restated Credit Agreement, dated as of February 24, 2005, among Chemed Corporation, the lenders from time to time parties thereto and JP Morgan Chase Bank, NA, as Administrative Agent.* 10.41 Pledge and Security Agreement, dated as of February 24, 2004, among Roto-Rooter, Inc., the subsidiaries of Roto-Rooter, Inc. listed on the signature pages thereto and Bank One, NA, as Collateral Agent.* 10.42 Guaranty Agreement, dated as of February 24, 2004, among the subsidiaries of Roto-Rooter, Inc. listed on the signature pages thereto and Bank One, NA, as Administrative Agent.* 34
10.43 Collateral Sharing Agreement, dated as of February 24, 2004, among Bank One, NA, as Collateral Agent and Administrative Agent, Wells Fargo Bank, NA, as Trustee, and Roto-Rooter, Inc.* 10.44 Form of Restricted Stock Award.*,** 10.45 Form of Stock Option Grant.*,** 10.46 Assets Purchase Agreement of April 1, 2005 between Service America Network, Inc. and Service America Enterprise, Inc.* 12 Computation of Ratio of Earnings to Fixed Charges. 13 2005 Annual Report to Stockholders. 14 Policies on Business Ethics of Chemed Corporation.* 21 Subsidiaries of Chemed Corporation. 23 Consent of Independent Registered Public Accounting Firm. 24 Powers of Attorney. 31.1 Certification by Kevin J. McNamara pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act of 1934. 31.2 Certification by David P. Williams pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act of 1934. 31.3 Certification by Arthur V. Tucker, Jr. pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act of 1934. 32.1 Certification by Kevin J. McNamara pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification by David P. Williams pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.3 Certification by Arthur V. Tucker, Jr. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * This exhibit is being filed by means of incorporation by reference (see Index to Exhibits on page E-1). Each other exhibit is being filed with this Annual Report on Form 10-K. ** Management contract or compensatory plan or arrangement. FINANCIAL STATEMENT SCHEDULE See Index to Financial Statements and Financial Statement Schedule on page S-1. 35
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHEMED CORPORATION March 13, 2006 By /s/ Kevin J. McNamara ------------------------------------- Kevin J. McNamara President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Kevin J. McNamara President and Chief Executive ] - -------------------------- Officer and a Director ] Kevin J. McNamara (Principal Executive Officer) ] ] ] /s/ David P. Williams Vice President and Chief ] - -------------------------- Financial Officer ] David P. Williams (Principal Financial Officer) ] ] ] /s/ Arthur V. Tucker, Jr. Vice President and ] March 13, 2006 - -------------------------- Controller (Principal ] Arthur V. Tucker, Jr. Accounting Officer) ] ] Edward L. Hutton* Walter L. Krebs* ] ] Donald Breen, Jr.* Sandra E. Laney* ] ] Charles H. Erhart, Jr.* Timothy S. O'Toole* ] --Directors ] Joel F. Gemunder* Donald E. Saunders* ] ] Patrick P. Grace* George J. Walsh III* ] ] Thomas C. Hutton* Frank E. Wood* ] ] - ---------- * Naomi C. Dallob by signing her name hereto signs this document on behalf of each of the persons indicated above pursuant to powers of attorney duly executed by such persons and filed with the Securities and Exchange Commission. March 13, 2006 /s/ Naomi C. Dallob Date ---------------------------------------- Naomi C. Dallob (Attorney-in-Fact) 36
CHEMED CORPORATION AND SUBSIDIARY COMPANIES INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE 2003, 2004 AND 2005 PAGE(s) CHEMED CORPORATION CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Report of Independent Registered Public Accounting Firm..................................... 6* Consolidated Statement of Operations........................................................ 7* Consolidated Balance Sheet.................................................................. 8* Consolidated Statement of Cash Flows........................................................ 9* Consolidated Statement of Changes in Stockholders' Equity................................... 10-11* Consolidated Statement of Comprehensive Income/(Loss)....................................... 10* Notes to Consolidated Financial Statements.................................................. 12* Report of Independent Registered Public Accounting Firm on Financial Statement Schedule..... S-2 Schedule II -- Valuation and Qualifying Accounts............................................ S-3 * Indicates page numbers in Chemed Corporation 2005 Annual Report to Stockholders. The consolidated financial statements of Chemed Corporation listed above, appearing in the 2005 Annual Report to Stockholders, are incorporated herein by reference. The Financial Statement Schedule should be read in conjunction with the consolidated financial statements listed above. Schedules not included have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto as listed above. S-1
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule To the Board of Directors of Chemed Corporation Our audits of the consolidated financial statements, of management's assessment of the effectiveness of internal control over financial reporting and of the effectiveness of internal control over financial reporting referred to in our report dated March 16, 2006 appearing in the 2005 Annual Report to Stockholders of Chemed Corporation (which report, consolidated financial statements and assessment are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Cincinnati, Ohio March 16, 2006 S-2
SCHEDULE II CHEMED CORPORATION AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) DR/(CR) ADDITIONS ------------------------ (CHARGED) APPLICABLE CREDITED (CHARGED) TO BALANCE AT TO COSTS CREDITED COMPANIES BALANCE BEGINNING AND TO OTHER ACQUIRED DEDUCTIONS AT END DESCRIPTION OF PERIOD EXPENSES ACCOUNTS IN PERIOD (b) OF PERIOD - ----------------------- ---------- --------- --------- ---------- ---------- --------- Allowances for doubtful accounts (c) For the year 2005 $ (7,544) $ (7,224) $ - $ - $ 6,355 $ (8,413) ========== ======== ========= ========== ========== ========= For the year 2004 (a) $ (2,646) $ (5,983) $ - $ (4,946) $ 6,031 $ (7,544) ========== ======== ========= ========== ========== ========= For the year 2003 (a) $ (3,337) $ (1,497) $ - $ - $ 2,188 $ (2,646) ========== ======== ========= ========== ========== ========= Allowances for doubtful accounts - notes receivable (d) For the year 2005 $ - $ - $ - $ - $ - $ - ========== ======== ========= ========== ========== ========= For the year 2004 $ (323) $ 323 $ - $ - $ - $ - ========== ======== ========= ========== ========== ========= For the year 2003 $ (422) $ 99 $ - $ - $ - $ (323) ========== ======== ========= ========== ========== ========= Valuation allowance for available-for-sale securities (e) For the year 2005 $ - $ - $ - $ - $ - $ - ========== ======== ========= ========== ========== ========= For the year 2004 $ - $ - $ - $ - $ - $ - ========== ======== ========= ========== ========== ========= For the year 2003 $ 5,668 $ - $ (278) $ - $ (5,390) $ - ========== ======== ========= ========== ========== ========= (a) Amounts were reclassified for operations discontinued in 2004. (b) With respect to allowances for doubtful accounts, deductions include accounts considered uncollectible or written off, payments, companies divested, etc. With respect to valuation allowance for available-for-sale securities, deductions comprise net realized gains on sales of investments. (c) Classified in consolidated balance sheet as a reduction of accounts receivable. (d) Classified in consolidated balance sheet as a reduction of other assets. (e) With respect to the valuation allowance for available-for-sale securities, amounts charged or credited to other accounts comprise net unrealized holding gains arising during the period. S-3
. . . EXHIBIT 10.35 Schedule to Exhibit 10.40 Employee Title Amount as of 2/21/06 - -------- ----- -------------------- Kevin J. McNamara President and Chief Executive Officer $484,186.00 Paid in full 2/22/06
EXHIBIT 12 CHEMED CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (IN THOUSANDS, EXCEPT RATIOS) 2001 2002 2003 2004 2005 -------- -------- -------- -------- -------- Pretax income/ (loss) from continuing operations before equity in earnings/ loss of affiliate $(15,478) $ 17,140 $ 16,446 $ 37,087 $ 57,283 Additions: Fixed charges 12,642 5,621 4,801 28,597 30,737 Amortization of capitalized interest - - - 1 2 Deductions: Capitalized interest - - - (72) (380) -------- -------- -------- -------- -------- Adjusted income/ (loss) $ (2,836) $ 22,761 $ 21,247 $ 65,613 $ 87,642 ======== ======== ======== ======== ======== Fixed Charges: Interest expense $ 6,537 $ 4,007 $ 3,211 $ 21,167 $ 21,264 Capitalized interest - - - 72 380 Interest component of rental expense 3,488 1,614 1,590 4,028 5,122 Loss on extinguishment of debt (a), (b), (c) 2,617 - - 3,330 3,971 -------- -------- -------- -------- -------- Fixed charges $ 12,642 $ 5,621 $ 4,801 $ 28,597 $ 30,737 ======== ======== ======== ======== ======== Ratio of earnings to fixed charges (d) n.a. 4.0 x 4.4 x 2.3 x 2.9 x ======== ======== ======== ======== ======== Additional earnings needed to achieve 1:1 ratio coverage (e) 15,478 n.a. n.a. n.a. n.a. ======== ======== ======== ======== ======== - --------------- (a) The year ended December 31, 2001 includes interest penalties related to the prepayment of the Company's 8.15% senior notes due 2002 through 2004 and its 10.67% senior notes due 2002 through 2003. (b) The year ended December 31, 2004 includes interest penalties related to the retirement of the Company's 7.31% senior notes due 2005 through 2009. Refer to Note 12 in the Notes to Consolidated Financial Statements for further discussion. (c) The year ended December 31, 2005 includes interest penalties related to the retirement of the Company's floating rate notes due 2010. Refer to Note 12 in the Notes to Consolidated Financial Statements for further discussion. (d) For purposes of computing the ratio of earnings to fixed charges, pretax income/ (loss) from continuing operations before equity in earnings/ (loss) of affiliate has been added to fixed charges and adjusted for capitalized interest to derive adjusted income/ (loss). Fixed charges consist of interest expense on debt (including the amortization of deferred financing costs), capitalized interest, prepayment penalties on the early extinguishment of debt and one-third (the proportion deemed representative of the interest component) of rental expense. Fixed charge amounts include interest from both continuing and discontinued operations. (e) In the year ended December 31, 2001 earnings were insufficient to cover fixed charges. Additional earnings of $15,478,000 must be generated to achieve a coverage ratio of 1:1.
EXHIBIT 13 1 FRONT COVER [CHEMED LOGO] CHEMED CORPORATION 2005 ANNUAL REPORT
2 INSIDE FRONT COVER LOGOS: CHEMED CORPORATION, VITAS, AND ROTO-ROOTER PROFILE: Publicly traded on the New York Stock Exchange under the symbol CHE, Chemed Corporation operates through two wholly owned subsidiaries, VITAS Healthcare Corporation and Roto-Rooter. VITAS is the nation's largest provider of end-of-life hospice care, and Roto-Rooter is North America's largest provider of plumbing and drain cleaning services. VITAS focuses on noncurative hospice care that helps make terminally ill patients' final days as comfortable and pain-free as possible. Through its teams of nurses, home health aides, doctors, social workers, clergy, and volunteers, VITAS provides direct medical services to patients, as well as spiritual and emotional counseling to both patients and their families. At year-end 2005, VITAS cared for more than 10,400 patients daily in 15 states, primarily in the patients' own homes, but also in VITAS' inpatient units located in hospitals, nursing homes, and assisted-living/residential-care facilities for the elderly. Roto-Rooter operates through more than 110 company-owned branches and independent contractors and approximately 500 franchisees. The total Roto-Rooter system offers services to more than 91% of the U.S. population and approximately 43% of the Canadian population. Roto-Rooter also has licensed master franchisees in China, including Hong Kong; the republics of Indonesia and Singapore; Japan; Mexico; the Philippines; and the United Kingdom. Founded in 1971, Chemed is headquartered in Cincinnati, Ohio.
3 FINE PRINT: Roto-Rooter(R) is a registered trademark of Roto-Rooter Corporation. VITAS(R) and Innovative Hospice Care(R) are registered trademarks of VITAS Healthcare Corporation. TABLE OF CONTENTS: CONTENTS Letter to Shareholders 1-4 Financial Review 5-54 Officers and Directors Listing and Corporate Information IBC
CHEMED LETTER TO SHAREHOLDERS V3 03.02.06 To Our Fellow Shareholders In last year's Letter to Shareholders we stated "The outlook for Chemed in terms of future opportunity and financial performance has never looked better." We are extremely pleased to report that our optimism has materialized into excellent 2005 financial results for both of our companies (VITAS Healthcare Corporation and Roto-Rooter Group Inc.) These robust operating results are derived from successfully executing our business philosophy - strive to be the best, most efficient operator in our industries. We have achieved best-in-class status by developing business models around market leaders with significant investment in a scalable management infrastructure. This model provides opportunities for increased efficiencies and competitive advantage in terms of cost and quality of service in existing markets as well as new territories. Furthermore, this operating model provides increased flexibility to manage changes, complications and paradigm shifts that continually challenge every business. FINANCIAL RESULTS* In 2005, Chemed had net service revenue and sales from continuing operations, in accordance with Generally Accepted Accounting Principles (GAAP), of $926 million - - an increase of 26% over the previous year. Income from continuing operations was $38 million, an increase of 97% compared to 2004. Diluted earnings per share from continuing operations increased more than 83% to $1.43. Our 2005 comparative financial results are enhanced by not owning 100% of VITAS in the prior year. This is why we internally measure operating results on an adjusted pro forma basis. Adjusted pro forma assumes we owned VITAS effective January 1, 2004 and eliminates certain transaction expenses related to the VITAS merger as well as other special items that we believe are not indicative of ongoing operations (Adjusted Pro Forma). Although this
perspective is on a non-GAAP basis, we believe this two-year Adjusted Pro Forma comparison appropriately reflects the fundamental performance of our operations. All of the following comments are based upon this Adjusted Pro Forma perspective. On an Adjusted Pro Forma basis, service revenues and sales in 2005 increased 15% to $926 million. Adjusted Pro Forma earnings before interest, taxes, depreciation and amortization (Adjusted Pro Forma EBITDA) were $124 million, up 26%. Adjusted Pro Forma EBITDA margins increased 122 basis points to 13.3%, and Adjusted Pro Forma net income was $51 million, up 56%. VITAS HEALTHCARE CORPORATION* VITAS produced record revenue and operating results in 2005. Adjusted Pro Forma revenue was $629 million, an increase of 18% compared to 2004. Adjusted Pro Forma EBITDA was $83 million, an increase of 28%. Net income was $46 million, which increased 34% over the prior year. Over 50,000 patients were admitted into VITAS' hospice programs during the year, we provided 3.8 million days of care, 95% of which was provided directly in patients' homes. The VITAS growth strategy is focused on a three-pronged approach. First and foremost is to garner increased market penetration in established programs. This is accomplished by providing quality hospice care to all of our patients and their families. We believe that market recognition of VITAS' high level of care will positively impact our ability to attract referrals and admissions earlier in a patient's terminal diagnosis. Our second area of growth opportunity at VITAS is through our new-start programs. This strategy begins by identifying communities with unmet hospice needs. We enter the communities with hospice care teams and commence the process of obtaining state and federal certification. This strategy generates operating losses as the new programs are established. Over the long term, however, we believe this will provide shareholders with significant return on capital once the programs are established. A third area of growth is acquisitions. We continue to search for hospice providers who will complement our existing culture of compassion and deeply committed approach to end-of-life care. Ideally, these acquisitions
will allow VITAS to enter new geographic regions that will provide stable platforms for future organic and new-start growth. This type of growth results in significant capital expenditures. At the same time, acquisitions provide the opportunity to immediately penetrate markets with established work forces, federal and state licensure, and established referral networks. VITAS' future performance depends upon the successful execution of all three of these expansion strategies. We believe VITAS is uniquely positioned to achieve such success through our market leadership, highly dedicated and focused personnel supported with an integrated management systems infrastructure. ROTO-ROOTER* Roto-Rooter completed 2005 with another record year. Service revenue and sales were $297 million, an increase of 7% compared to the prior year. Adjusted pro forma net income totaled $25 million, a 21% increase over 2004. Roto-Rooter operates in a very mature, fragmented industry with relatively low organic growth. The unusually strong earnings growth Roto-Rooter generated in 2005 was the result of efficiencies derived from re-engineering initiatives completed in 2004. These changes included centralizing call and dispatch locations, as well as instituting standardized procedures throughout the organization. This centralization provided the opportunity for efficient monitoring of technician scheduling and job backlog. It also removed significant non value-added administrative work from Roto-Rooter branches. In the future, Roto-Rooter will continue its focus on providing a high level of service to our residential and commercial customers in existing territories. In addition, we will continue to evaluate opportunities to acquire franchise territories that are reasonably valued and can be leveraged into Roto-Rooter's existing infrastructure. Perpetuating leadership within our industry segments requires commitment, vision and risk. Chemed eagerly accepts this challenge and is forging ahead with ideas and solutions that will enhance our services and provide significant benefits to our patients, customers and shareholders.
Kevin J. McNamara Edward L. Hutton President and Chairman of the Board Chief Executive Office * A reconciliation of GAAP earnings to Adjusted Pro Forma earnings can be found in Chemed Corporation's fourth-quarter 2005 earnings press release, dated February 21, 2006, which is available on the Chemed web site at www.chemed.com.
FINANCIAL REVIEW CONTENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 6 CONSOLIDATED STATEMENT OF OPERATIONS 7 CONSOLIDATED BALANCE SHEET 8 CONSOLIDATED STATEMENT OF CASH FLOWS 9 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY 10 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME/(LOSS) 10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12 UNAUDITED SUMMARY OF QUARTERLY RESULTS 38 SELECTED FINANCIAL DATA 40 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 41 MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as that term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Company's management, including the President and Chief Executive Officer, Vice President and Chief Financial Officer and Vice President and Controller, has conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2005 based on the framework established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2005 based on criteria in Internal Control--Integrated Framework issued by COSO. Management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm. 5
(PRICEWATERHOUSECOOPERS LOGO) REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors of Chemed Corporation: We have completed integrated audits of Chemed Corporation's 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements In our opinion, the accompanying consolidated balance sheet and the related consolidated statement of operations, cash flows, changes in stockholders' equity and comprehensive income/(loss) present fairly, in all material respects, the financial position of Chemed Corporation and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. Internal control over financial reporting Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over Financial Reporting appearing on page 5, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Cincinnati, Ohio March 16, 2006 6
CONSOLIDATED STATEMENT OF OPERATIONS Chemed Corporation and Subsidiary Companies (in thousands, except per share data) For the Years Ended December 31, 2005 2004 2003 - ------------------------------------- -------- -------- -------- CONTINUING OPERATIONS Service revenues and sales ........................... $926,477 $735,341 $260,776 -------- -------- -------- Cost of services provided and goods sold (excluding depreciation) ..................................... 651,841 507,078 146,818 Selling, general and administrative expenses ......... 151,670 138,285 95,363 Depreciation ......................................... 16,179 14,542 9,519 Amortization ......................................... 5,322 3,779 302 Other expenses (Note 5) .............................. 22,081 13,551 -- -------- -------- -------- Total costs and expenses .......................... 847,093 677,235 252,002 -------- -------- -------- Income from operations ............................ 79,384 58,106 8,774 Interest expense ..................................... (21,264) (21,158) (3,177) Loss on extinguishment of debt (Note 12) ............. (3,971) (3,330) -- Other income--net (Note 8) ........................... 3,134 3,469 10,849 -------- -------- -------- Income before income taxes ........................ 57,283 37,087 16,446 Income taxes (Note 9) ................................ (19,578) (13,796) (6,180) Equity in earnings/(loss) of affiliate (Note 3) ...... -- (4,105) 922 -------- -------- -------- Income from continuing operations ................. 37,705 19,186 11,188 DISCONTINUED OPERATIONS, NET OF INCOME TAXES (NOTE 6) ... (1,888) 8,326 (14,623) -------- -------- -------- NET INCOME/(LOSS) ....................................... $ 35,817 $ 27,512 $ (3,435) ======== ======== ======== EARNINGS/(LOSS) PER SHARE (NOTES 17 AND 25) Income from continuing operations .................... $ 1.48 $ 0.80 $ 0.56 ======== ======== ======== Net Income/(Loss) .................................... $ 1.40 $ 1.14 $ (0.17) ======== ======== ======== DILUTED EARNINGS/(LOSS) PER SHARE (NOTES 17 AND 25) Income from continuing operations .................... $ 1.43 $ 0.78 $ 0.56 ======== ======== ======== Net Income/(Loss) .................................... $ 1.36 $ 1.12 $ (0.17) ======== ======== ======== AVERAGE NUMBER OF SHARES OUTSTANDING (NOTES 17 AND 25) Earnings/(loss) per share ............................ 25,552 24,120 19,848 ======== ======== ======== Diluted earnings/(loss) per share .................... 26,299 24,636 19,908 ======== ======== ======== The Notes to Consolidated Financial Statements are integral parts of this statement. 7
CONSOLIDATED BALANCE SHEET Chemed Corporation and Subsidiary Companies (in thousands, except shares and per share data) December 31, 2005 2004 - ------------------------------------------------ -------- -------- ASSETS Current assets Cash and cash equivalents (Note 10) ...................................... $ 57,133 $ 71,448 Accounts receivable less allowances of $8,413 (2004 - $7,544) ............ 95,063 64,663 Inventories .............................................................. 6,499 7,019 Prepaid income taxes ..................................................... 9,096 -- Current deferred income taxes (Note 9) ................................... 26,691 31,250 Current assets of discontinued operations (Note 6) ....................... -- 13,397 Prepaid expenses and other current assets ................................ 9,768 9,842 -------- -------- Total current assets .................................................. 204,250 197,619 Investments of deferred compensation plans held in trust (Note 14) .......... 21,105 18,317 Other investments (Notes 6 and 16) .......................................... 1,445 1,445 Note receivable (Notes 6 and 16) ............................................ 12,500 12,500 Properties and equipment, at cost, less accumulated depreciation (Note 11) .. 65,449 55,796 Identifiable intangible assets less accumulated amortization of $9,612 (2004 - $5,174) (Notes 4 and 7) .......................................... 75,358 76,924 Goodwill (Notes 4 and 7) .................................................... 433,756 432,732 Noncurrent assets of discontinued operations (Note 6) ....................... -- 5,705 Other assets ................................................................ 21,222 24,528 -------- -------- Total Assets ....................................................... $835,085 $825,566 ======== ======== LIABILITIES Current liabilities Accounts payable ......................................................... $ 43,626 $ 37,777 Current portion of long-term debt (Note 12) .............................. 1,045 12,185 Income taxes payable ..................................................... 3,916 10,944 Accrued insurance ........................................................ 38,894 26,350 Accrued salaries and wages ............................................... 19,952 17,030 Current liabilities of discontinued operations (Note 6) .................. -- 22,117 Other current liabilities (Note 13) ...................................... 61,462 42,777 -------- -------- Total current liabilities ............................................. 168,895 169,180 Deferred income taxes (Note 9) .............................................. 22,304 16,814 Long-term debt (Note 12) .................................................... 234,058 279,510 Deferred compensation liabilities (Note 14) ................................. 21,275 18,311 Noncurrent liabilities of discontinued operations (Note 6) .................. -- 811 Other liabilities ........................................................... 4,378 8,848 Commitments and contingencies (Notes 13, 15, 19, 22, 23) -------- -------- Total Liabilities .................................................. 450,910 493,474 -------- -------- STOCKHOLDERS' EQUITY Capital stock - authorized 40,000,000 shares $1 par; issued 28,373,872 shares (2004 - 13,491,341 pre-split shares) .............................. 28,374 13,491 Paid-in capital ............................................................. 237,917 212,691 Retained earnings ........................................................... 171,188 141,542 Treasury stock - 2,394,272 shares (2004 - 983,128 pre-split shares), at cost ..................................................................... (52,127) (33,873) Unearned compensation (Note 14) ............................................. (3,007) (3,590) Deferred compensation payable in Company stock (Note 14) .................... 2,379 2,375 Notes receivable for shares sold (Note 18) .................................. (549) (544) -------- -------- Total Stockholders' Equity ......................................... 384,175 332,092 -------- -------- Total Liabilities and Stockholders' Equity ......................... $835,085 $825,566 ======== ======== The Notes to Consolidated Financial Statements are integral parts of this statement. 8
CONSOLIDATED STATEMENT OF CASH FLOWS Chemed Corporation and Subsidiary Companies (in thousands) For the Years Ended December 31, 2005 2004 2003 - ----------------------------------------------- --------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income/(loss) .............................................................. $ 35,817 $ 27,512 $ (3,435) Adjustments to reconcile net income/(loss) to net cash provided by operations: Depreciation and amortization ............................................... 21,501 18,321 9,821 Provision for uncollectible accounts receivable ............................. 7,224 6,155 1,497 Noncash portion of long-term incentive compensation ......................... 4,813 4,988 -- Provision for deferred income taxes (Note 9) ................................ (3,682) 5,002 1,214 Write-off of unamortized debt issuance costs ................................ 2,871 -- -- Amortization of debt issuance costs ......................................... 1,834 1,861 -- Discontinued operations (Note 6) ............................................ 1,888 (8,326) 14,623 Equity in loss/(earnings) of affiliate (Note 3) ............................. -- 4,105 (922) Gains on redemption and sales of available-for-sale investments ............. -- -- (5,390) Changes in operating assets and liabilities, excluding amounts acquired in business combinations: Increase in accounts receivable .......................................... (37,753) (6,534) (1,843) Decrease/(increase) in inventories ....................................... 520 (986) (618) Decrease/(increase) in prepaid expenses and other current assets ......... 76 11,659 (801) Increase/(decrease) in accounts payable and other current liabilities .... 33,036 (2,497) 502 Increase in income taxes ................................................. 14,112 21,374 2,972 Decrease/(increase) in other assets ...................................... (2,003) 5,607 (2,041) Increase/(decrease) in other liabilities ................................. (1,142) (627) 2,842 Noncash expense of internally financed ESOPs ................................ 1,060 1,894 1,740 Other sources/(uses) ........................................................ 1,400 (1,044) 1,129 --------- --------- -------- Net cash provided by continuing operations ............................... 81,572 88,464 21,290 Net cash (used)/provided by discontinued operations (Note 6) (1,559) 4,426 2,487 --------- --------- -------- Net cash provided by operating activities ................................ 80,013 92,890 23,777 --------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures ........................................................... (25,956) (18,290) (10,381) Net proceeds/(uses) from sale of discontinued operations (Note 6) .............. (9,367) (759) 1,091 Business combinations, net of cash acquired (Note 7) ........................... (6,207) (344,727) (3,850) Proceeds from sales of property and equipment .................................. 157 772 555 Deposit to secure merger offer ................................................. -- 10,000 (10,000) Proceeds from redemption of available-for-sale securities (Note 3) ............. -- -- 27,270 Proceeds from sales of investments ............................................. -- -- 4,493 Purchase of equity investment in affiliate (VITAS) (Note 3) .................... -- -- (17,999) Investing activities of discontinued operations (Note 6) ....................... -- (98) 1,396 Other uses ..................................................................... (369) (107) (357) --------- --------- -------- Net cash used by investing activities ....................................... (41,742) (353,209) (7,782) --------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Repayment of long-term debt (Note 12) .......................................... (141,592) (96,940) (92) Proceeds from issuance of long-term debt (Note 12) ............................. 85,000 295,000 -- Proceeds from exercise of stock options (Note 18) .............................. 12,327 3,721 3,287 Purchases of treasury stock .................................................... (7,401) (2,654) (637) Increase/(decrease) in cash overdraft payable .................................. 6,752 1,265 (925) Dividends paid ................................................................. (6,172) (5,718) (4,761) Debt issuance costs ............................................................ (1,755) (14,447) -- Issuance of capital stock, net of costs (Note 7) ............................... -- 95,102 -- Collection of stock subscription note receivable ............................... -- 8,053 -- Financing activities of discontinued operations (Note 6) ....................... -- (255) (317) Redemption of convertible junior subordinated securities (Note 20) ............. -- (2,735) -- Other sources .................................................................. 255 687 568 --------- --------- -------- Net cash provided/(used) by financing activities ............................ (52,586) 281,079 (2,877) --------- --------- -------- INCREASE IN CASH AND CASH EQUIVALENTS ............................................. (14,315) 20,760 13,118 Cash and cash equivalents at beginning of year .................................... 71,448 50,688 37,570 --------- --------- -------- Cash and cash equivalents at end of year .......................................... $ 57,133 $ 71,448 $ 50,688 ========= ========= ======== The Notes to Consolidated Financial Statements are integral parts of this statement. 9
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Chemed Corporation and Subsidiary Companies (in thousands, Capital Paid-in Retained except per share data) Stock Capital Earnings - ---------------------- ------- -------- -------- Balance at December 31, 2002 ................... $13,448 $168,299 $127,938 Net loss ..................... -- -- (3,435) Dividends paid ($0.48 per share - pre-split) ........ -- -- (4,761) Decrease in unearned compensation (Note 14) .... -- -- -- Stock awards and exercise of stock options (Note 18) ... 3 1,620 -- Other comprehensive loss ..... -- -- -- Decrease in notes receivable (Note 18) ................. -- -- -- Purchases of treasury stock .. -- -- -- Distribution of assets to settle deferred compensation liabilities .. -- -- -- Other ........................ 2 582 4 ------- -------- -------- Balance at December 31, 2003 ................... 13,453 170,501 119,746 Net income ................... -- -- 27,512 Dividends paid ($0.48 per share - pre-split) ........ -- -- (5,718) Stock awards and exercise of stock options (Note 18) ... 130 10,650 -- Retirement of treasury shares .................... (400) (12,076) -- Issuance of common shares (Note 7) .................. -- 32,722 -- Decrease in notes receivable (Note 18) ................. -- -- -- Purchases of treasury stock .. -- -- -- Conversion of convertible preferred securities ...... 308 10,639 -- Other ........................ -- 255 2 ------- -------- -------- BALANCE AT DECEMBER 31, 2004 ................... 13,491 212,691 141,542 NET INCOME ................... -- -- 35,817 DIVIDENDS PAID ($0.24 PER SHARE) . .................. -- -- (6,172) STOCK AWARDS AND EXERCISE OF STOCK OPTIONS (NOTE 18) ... 1,028 38,860 -- DECREASE IN NOTES RECEIVABLE (NOTE 18) ................. -- -- -- PURCHASES OF TREASURY STOCK .. -- -- -- IMPACT OF COMMON SHARE SPLIT (NOTE 25) ................. 13,855 (13,855) -- OTHER ........................ -- 221 1 ------- -------- -------- BALANCE AT DECEMBER 31, 2005 ................... $28,374 $237,917 $171,188 ======= ======== ======== The Notes to Consolidated Financial Statements are integral parts of this statement. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME/(LOSS) Chemed Corporation and Subsidiary Companies (in thousands) For the Years Ended December 31, 2005 2004 2003 - ----------------------------------------------- ------- ------- ------- Net income/(loss) .................................................. $35,817 $27,512 $(3,435) ------- ------- ------- Other comprehensive income/(loss), net of income tax: Unrealized holding gains/(losses) on available-for-sale investments arising during the period ........................ -- -- (334) Less: Reclassification adjustment for gains on available-for-sale investments arising during the period ........................ -- -- (3,351) ------- ------- ------- Total ........................................................ -- -- (3,685) ------- ------- ------- Comprehensive income/(loss) ........................................ $35,817 $27,512 $(7,120) ======= ======= ======= The Notes to Consolidated Financial Statements are integral parts of this statement. 10
Deferred Compensation Accumulated Notes Treasury Payable in Other Receivable Stock- Unearned Company Comprehensive for Shares at Cost Compensation Stock Income Sold Total - --------- ------------ ------------ ------------- ---------- -------- $(111,582) $(4,694) $2,280 $ 3,685 $ (952) $198,422 -- -- -- -- -- (3,435) -- -- -- -- -- (4,761) -- 1,740 -- -- -- 1,740 2,216 -- -- -- -- 3,839 -- -- -- (3,685) -- (3,685) (23) -- -- -- 18 (5) (69) -- -- -- -- (69) 31 -- (31) -- -- -- -- -- 59 -- -- 647 - --------- ------- ------ ------- ------- -------- (109,427) (2,954) 2,308 -- (934) 192,693 -- -- -- -- -- 27,512 -- -- -- -- -- (5,718) 771 (2,530) -- -- -- 9,021 12,476 -- -- -- -- -- 62,380 -- -- -- -- 95,102 (10) -- -- -- 390 380 (63) 1,894 -- -- -- 1,831 -- -- -- -- -- 10,947 -- -- 67 -- -- 324 - --------- ------- ------ ------- ------- -------- (33,873) (3,590) 2,375 -- (544) 332,092 -- -- -- -- -- 35,817 -- -- -- -- -- (6,172) (18,204) (477) -- -- -- 21,207 (9) -- -- -- (5) (14) (41) 1,060 -- -- -- 1,019 -- -- -- -- -- -- -- -- 4 -- -- 226 - --------- ------- ------ ------- ------- -------- $ (52,127) $(3,007) $2,379 $ -- $ (549) $384,175 ========= ======= ====== ======= ======= ======== 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Chemed Corporation and Subsidiary Companies 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS We operate through our two wholly owned subsidiaries, VITAS Healthcare Corporation ("VITAS") and Roto-Rooter Group, Inc. ("Roto-Rooter"). VITAS focuses on hospice care that helps make terminally ill patients' final days as comfortable as possible. Through its team of doctors, nurses, home health aides, social workers, clergy and volunteers, VITAS provides direct medical services to patients, as well as spiritual and emotional counseling to both patients and their families. Roto-Rooter is focused on providing plumbing and drain cleaning services to both residential and commercial customers. Through its network of company-owned branches, independent contractors and franchisees, Roto-Rooter offers plumbing and drain cleaning service to over 90% of the U.S. population. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Chemed Corporation and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated. Long-term investments in affiliated companies representing ownership interests of 20% to 50% were accounted for using the equity method. Effective January 1, 2004, we adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 46R "Consolidation of Variable Interest Entities--an interpretation of Accounting Research Bulletin No. 51 (revised)" ("FIN 46R") relative to contractual relationships with our independent contractors and franchisees. FIN 46R requires the primary beneficiary of a Variable Interest Entity ("VIE") to consolidate the accounts of the VIE. We have evaluated the relationships with our independent contractors and franchisees based upon guidance provided in FIN 46R and have concluded that certain of the independent contractors may be VIEs. Based on our evaluation, the franchisees are not VIEs. We believe consolidation, if required, of the accounts of any independent contractor for which we might be the primary beneficiary would not materially impact our financial position or results of operations. CASH EQUIVALENTS Cash equivalents comprise short-term, highly liquid investments that have been purchased within three months of their dates of maturity. ACCOUNTS AND LOANS RECEIVABLE AND CONCENTRATION OF RISK Accounts and loans receivable are recorded at the principal balance outstanding less estimated allowances for uncollectible accounts. For the Roto-Rooter segment, allowances for trade accounts receivable are generally provided for accounts more than 90 days past due, although collection efforts continue beyond that time. Due to the small number of loans receivable outstanding, allowances for loan losses are determined on a case-by-case basis. For the VITAS segment, allowances for patient accounts receivable are generally provided on accounts more than 240 days old plus an appropriate percentage of accounts not yet 240 days old. Final write-off of overdue accounts or loans receivable is made when all reasonable collection efforts have been made and payment is not forthcoming. We closely monitor our receivables and periodically review procedures for granting credit to attempt to hold losses to a minimum. As of December 31, 2005 and 2004, approximately 65% and 56%, respectively of VITAS' total accounts receivable balance were due from Medicare and 27% and 32%, respectively of VITAS' total accounts receivable balance were due from various state Medicaid programs. We closely monitor our programs to ensure compliance with Medicare and Medicaid regulations. INVENTORIES Substantially all of the inventories are either general merchandise or finished goods. Inventories are stated at the lower of cost or market. For determining the value of inventories, cost methods that reasonably approximate the first-in, first-out ("FIFO") method are used. OTHER INVESTMENTS At December 31, 2005 and 2004, other investments, which are classified as available-for-sale, comprise a common stock purchase warrant in privately held Patient Care Inc. ("Patient Care"), our former subsidiary. As further discussed in Note 16, our investment in the Patient Care warrant is carried at cost, subject to write-down for impairment. All investments are reviewed periodically for impairment based on available market and financial data. If the market value or net realizable value of the investment is less than our cost and the decline is determined to be other than temporary, a write-down to fair value is made, and a realized loss is recorded in the statement of operations. In calculating realized gains and losses on the sales of investments, the specific-identification method is used to determine the cost of investments sold. 12
Chemed Corporation and Subsidiary Companies DEPRECIATION AND PROPERTIES AND EQUIPMENT Depreciation of properties and equipment is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the remaining lease terms (excluding option terms) or their useful lives. Expenditures for maintenance, repairs, renewals and betterments that do not materially prolong the useful lives of the assets are expensed as incurred. The cost of property retired or sold and the related accumulated depreciation are removed from the accounts, and the resulting gain or loss is reflected currently in income. Expenditures for major software purchases and software developed for internal use are capitalized and depreciated using the straight-line method over the estimated useful lives of the assets. For software developed for internal use, external direct costs for materials and services and certain internal payroll and related fringe benefit costs are capitalized in accordance with Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The weighted average lives of our property and equipment at December 31, 2005, were: Buildings 17.1 yrs. Transportation equipment 5.9 Machinery and equipment 6.1 Computer software 4.5 Furniture and fixtures 5.1 GOODWILL AND INTANGIBLE ASSETS Identifiable, definite-lived intangible assets arise from purchase business combinations and are amortized using either an accelerated method or the straight-line method over the estimated useful lives of the assets. The selection of an amortization method is based on which method best reflects the economic pattern of usage of the asset. The VITAS trade name is considered to have an indefinite life. Goodwill and the VITAS trade name are tested at least annually for impairment. The weighted average lives of our identifiable, definite-lived intangible assets at December 31, 2005, were: Covenants not to compete 6.3 yrs. Referral networks 9.9 Customer lists 13.3 LONG-LIVED ASSETS We periodically make an estimation and valuation of the future benefits of our long-lived assets (other than goodwill and the VITAS trade name) based on key financial indicators. If the projected undiscounted cash flows of a major business unit indicate that property and equipment or identifiable, definite-lived intangible assets have been impaired, a write-down to fair value is made. No events occurred during the year ended December 31, 2005 that indicated an impairment assessment was required. OTHER ASSETS Debt issuance costs are included in other assets and are amortized using the effective interest method over the life of the debt. REVENUE RECOGNITION For both the Roto-Rooter and VITAS segments, service revenues and sales are recognized when the earnings process has been completed. Generally, this occurs when services are provided or products are delivered. VITAS recognizes revenue at the estimated net realizable amount due from third-party payers, which are primarily Medicare and Medicaid. Payers may deny payment for services in whole or in part on the basis that such services are not eligible for coverage and do not qualify for reimbursement. We estimate denials each period and make adequate provision in the financial statements. VITAS is subject to certain limitations on Medicare payments for services. Specifically, if the number of inpatient care days any hospice program provides to Medicare beneficiaries exceeds 20% of the total days of hospice care such program provided to all Medicare patients for an annual period beginning September 28, the days in excess of the 20% figure may be reimbursed only at the routine homecare rate. None of VITAS' hospice programs exceeded the payment limits on inpatient services in 2005 or 2004. 13
Chemed Corporation and Subsidiary Companies VITAS is also subject to a Medicare annual per-beneficiary cap ("Medicare Cap"). Compliance with the Medicare Cap is measured by comparing the total Medicare payments received under a Medicare provider number with respect to services provided to all Medicare hospice care beneficiaries in the program or programs covered by that Medicare provider number between November 1 of each year and October 31 of the following year with the product of the per-beneficiary cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice program or programs from September 28 through September 27 of the following year. We actively monitor each of our hospice programs, by provider number, for their Medicare revenue, admissions, discharge rate and average length of stay data in an attempt to determine whether they are likely to exceed the Medicare Cap. Should we determine a provider number is likely to exceed the Medicare Cap based on projected trends, we attempt to institute corrective action to influence the patient mix or to increase patient admissions. However, should we project our corrective action will not prevent that program from exceeding its Medicare Cap, we estimate the amount we will be required to repay at the end of the measurement year and accrue that amount, which is proportional to the number of months elapsed in the Medicare Cap year, as a reduction of patient revenue. As discussed in Note 7, during the second quarter of 2005, we determined that the Phoenix, AZ facility, which was acquired in December 2004, had exceeded the Medicare Cap for the measurement period ended October 31, 2005. An estimated liability of $1.0 million was recorded at that time. We increased the liability in the fourth quarter of 2005 to $2.4 million based on revised estimates. The increase in the estimated liability from the second quarter to the fourth quarter is the result of a change in the discharge trends for patients admitted prior to our acquisition of the Phoenix facility. Because the estimated Medicare Cap liability is related to patients being cared for at the time of acquisition, this liability was recorded as an assumed liability. None of VITAS' other programs exceeded the Medicare Cap in 2005 or 2004. GUARANTEES In the normal course of business, we enter into various guarantees and indemnifications in our relationships with customers and others. Examples of these arrangements include guarantees of services for periods ranging from one day to one year and product satisfaction guarantees. Our experience indicates guarantees and indemnifications do not materially impact our financial condition or results of operations. Based on our experience, no liability for guarantees has been recorded as of December 31, 2005 or 2004. OPERATING EXPENSES Cost of services provided and goods sold (excluding depreciation) includes salaries, wages and benefits of service providers and field personnel, material costs, medical supplies and equipment, pharmaceuticals, insurance costs, service vehicle costs and other expenses directly related to providing service revenues or generating sales. Selling, general and administrative expenses include salaries, wages and benefits of selling, marketing and administrative employees, advertising expenses, communications and branch telephone expenses, office rent and operating costs, legal, banking and professional fees and other administrative costs. ADVERTISING We expense the production costs of advertising the first time the advertising takes place. Costs of yellow pages listings are expensed when the directories are placed in circulation. These directories are generally in circulation for approximately one year, at which point they are replaced by the publisher with a new directory. We do not control the timing of when a new directory is placed in circulation. Other advertising costs are expensed as incurred. Advertising expense for continuing operations for the year ended December 31, 2005, was $21.2 million (2004--$20.0 million; 2003--$16.4 million). COMPUTATION OF EARNINGS PER SHARE Earnings per share are computed using the weighted average number of shares of capital stock outstanding. Diluted earnings per share reflect the dilutive impact of our outstanding stock options and nonvested stock awards. Diluted earnings per share also assumed the conversion of the Convertible Junior Subordinated Debentures ("CJSD") into capital stock prior to the redemption of the CJSD in 2004, only when the impact was dilutive on earnings per share from continuing operations. Stock options whose exercise price are greater than the average market price of our stock are excluded from the computation of diluted earnings per share. EMPLOYEE STOCK OWNERSHIP PLANS Contributions to our Employee Stock Ownership Plans ("ESOP") are based on established debt repayment schedules. Shares are allocated to participants based on the principal and interest payments made during the period. Our policy is to record ESOP expense by applying the transition rule under the level-principal amortization concept. 14
Chemed Corporation and Subsidiary Companies STOCK-BASED COMPENSATION PLANS We use Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees", to account for stock-based compensation. Since our stock options qualify as fixed options under APB 25 and since the option price equals the market price on the date of grant, there is no compensation cost recorded for stock options. Restricted stock is recorded as compensation cost over the requisite vesting periods on a straight-line basis, based on the market value on the date of grant. The following table illustrates the effect on net income/(loss) and earnings/(loss) per share if we had applied the fair-value-recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation" (in thousands, except per share data): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------- ------- Net income/(loss), as reported $35,817 $27,512 $(3,435) Add: stock-based compensation expense included in the determination of net income/(loss), net of income taxes 4,314 3,940 95 Deduct: total stock-based employee compensation determined under a fair-value-based method for all stock options and awards, net of related income taxes (8,519) (8,259) (952) ------- ------- ------- Pro forma net income/(loss) $31,612 $23,193 $(4,292) ======= ======= ======= Earnings/(loss) per share As reported $ 1.40 $ 1.14 $ (0.17) ======= ======= ======= Pro forma $ 1.24 $ 0.96 $ (0.22) ======= ======= ======= Diluted earnings/(loss) per share As reported $ 1.36 $ 1.12 $ (0.17) ======= ======= ======= Pro forma $ 1.20 $ 0.94 $ (0.22) ======= ======= ======= The above pro forma data were calculated using the Black-Scholes option valuation method to value our stock options granted in 2005 and prior years. Key assumptions include: For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------ ------ ------ Weighted average grant-date fair value of options granted $12.43 $ 6.80 $ 5.07 Risk-free interest rate 4.0% 3.9% 3.2% Expected volatility 30.9% 30.3% 27.8% Expected life of options 5 yrs. 5 yrs. 6 yrs. For options granted in 2003, it was assumed that we would increase the annual dividend $0.005 per share per quarter biannually in the fourth quarter. For options granted in 2005 and 2004, it was assumed that the annual dividend would remain at $0.24 per share for the life of the options. These assumptions were based on the facts and circumstances that existed at the time options were granted and should not be construed to be an indication of any future dividend amounts to be paid. INSURANCE ACCRUALS For our Roto-Rooter segment and Corporate Office, we self-insure for all casualty insurance claims (workers' compensation, auto liability and general liability). As a result, we closely monitor and frequently evaluate our historical claims experience to estimate the appropriate level of accrual for self-insured claims. Our third-party administrator ("TPA") processes and reviews claims on a monthly basis. Currently, our exposure on any single claim is capped at $500,000. For most of the prior years, the caps for general liability and workers' compensation were between $250,000 and $500,000 per claim. In developing our estimates, we accumulate historical claims data for the previous 10 years to calculate loss 15
Chemed Corporation and Subsidiary Companies development factors ("LDF") by insurance coverage type. LDFs are applied to known claims to estimate the ultimate potential liability for known and unknown claims for each open policy year. LDFs are updated annually. Because this methodology relies heavily on historical claims data, the key risk is whether the historical claims are an accurate predictor of future claims exposure. The risk also exists that certain claims have been incurred and not reported on a timely basis. To mitigate these risks, in conjunction with our TPA, we closely monitor claims to ensure timely accumulation of data and compare claims trends with the industry experience of our TPA. For the VITAS segment, we self-insure for workers' compensation exposures. Currently, VITAS' exposure on any single claim is capped at $500,000. For most of the prior years, the caps for workers' compensation were between $250,000 and $500,000 per claim. For VITAS' self-insurance accruals for workers' compensation, we obtained an actuarial valuation of the liability as of the date of acquisition and as of November 30, 2005 and 2004. The valuation methods used by the actuary are similar to those used internally for our other business units. TAXES ON INCOME Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amount of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in laws and rates on the date of enactment. We are subject to income taxes in Canada, the U.S. Federal and most state jurisdictions. Significant judgment is required to determine our provision for income taxes. We are periodically audited by various taxing authorities. We establish liabilities for possible assessments by taxing authorities resulting from exposures including, but not limited to, the deductibility of certain expenses and the tax treatment of acquisitions and divestitures. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe our tax reserves reflect the probable outcome of known contingencies, including interest and penalties, if applicable. On June 30, 2005, the State of Ohio enacted significant changes to its tax system. The impact was required to be accounted for in all annual and interim periods ending on or after June 30, 2005. Changes include the phasing out of the Ohio income tax and the Ohio personal property tax. Additionally, a new Commercial Activity Tax ("CAT"), which is based on gross receipts, was introduced. Since the corporate income tax was replaced by the CAT, which is not an income tax under generally accepted accounting principles, entities with businesses in the State of Ohio must account for the phase-out of the corporate income tax as a change in enacted tax rate as of June 30, 2005. We historically recorded a valuation allowance on all significant deferred tax amounts in the State of Ohio, primarily net operating loss carry-forwards, because we believed it was more likely than not that the benefit would expire unutilized. As such, there was no significant impact to us for the year ended December 31, 2005. ESTIMATES The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Disclosures of aftertax expenses and adjustments are based on estimates of the effective income tax rates for the applicable segments. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the 2005 presentation. As discussed in Note 25, prior period share and per share data has been restated to retroactively reflect the impact of the capital stock split in May 2005. The shares outstanding and in treasury reflected on the balance sheet prior to May 11, 2005 have not been restated. Cash overdrafts payable have been reclassified as a separate component of cash flow from financing activities in the statement of cash flows for 2004 and 2003 to conform to the 2005 presentation. RECENT ACCOUNTING STATEMENTS In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB Statement No. 123 (revised 2004) "Share-Based Payment" ("FASB123R"), which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees and disallows the use of the intrinsic value method of accounting for stock options, but expresses no preference for a type of valuation model. This statement supersedes APB No. 25, but does not change the accounting guidance for share-based payment transactions with parties other than employees provided in FASB 123 as originally issued. FASB123R is effective as of January 1, 2006. In March 2005, the Board of Directors approved immediate vesting of all unvested stock options to avoid recognizing approximately $951,000 of pretax expense that would have been charged to income under FASB123R beginning on January 1, 2006. The pretax expense from continuing operations of accelerating the vesting of these stock options, which were 16
Chemed Corporation and Subsidiary Companies scheduled to vest in November 2005 and November 2006, was approximately $215,000 and was recorded in the first quarter of 2005. We adopted FASB 123R on January 1, 2006 using the modified prospective method. Therefore, historical financial information will not be restated. There was no significant impact on our financial condition, results of operations or cash flow as a result of adoption of FASB 123R. In May 2005, the FASB issued FASB Statement No. 154, "Accounting for Changes and Error Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3." FASB 154 changes the requirements with regard to the accounting for and reporting of a change in an accounting principle. The provisions of FASB 154 require, unless impracticable, retrospective application to prior periods presented in financial statements for all voluntary changes in an accounting principle and changes required by the adoption of a new accounting pronouncement in the unusual instance that the new pronouncement does not indicate a specific transition method. FASB 154 also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in an accounting estimate, which requires prospective application of the new method. FASB 154 is effective for all changes in an accounting principle made in fiscal years beginning after December 15, 2005. We adopted FASB 154 with our fiscal year beginning January 1, 2006. There was no impact on our financial condition, results of operations or cash flows upon adoption. In February 2006, the FASB issued FASB Statement No. 155, "Accounting for Certain Hybrid Financial Instruments", which nullifies and amends various accounting guidance relating to accounting for derivative instruments and securitization transactions. In general, these changes will reduce the operational complexity associated with bifurcating embedded derivatives, and increase the number of beneficial interests in securitization transactions. This statement is effective for all financial instruments acquired or issued after the beginning of our first fiscal year that begins after September 15, 2006. Because we do not have any material derivative instruments or securitization transactions, we believe there will be no material impact on our financial condition, results of operations or cash flows upon adoption. 2. SEGMENTS AND NATURE OF THE BUSINESS Our segments comprise the VITAS segment and the Roto-Rooter segment (formerly the Plumbing and Drain Cleaning segment). Service America has been reclassified to discontinued operations for all periods presented. Relative contributions of each segment to service revenues and sales were 68% and 32%, respectively, in 2005. Relative contributions of each segment to service revenues and sales were 62% and 38%, respectively, in 2004. The reportable segments have been defined along service lines which is consistent with the way the businesses are managed. In determining reportable segments, the Roto-Rooter Services; and Roto-Rooter Franchising and Products operating units of the Roto-Rooter segment have been aggregated on the basis of possessing similar operating and financial characteristics. The characteristics of these operating segments and the basis for aggregation are reviewed annually. Accordingly, the reportable segments are defined as follows: - The VITAS segment provides hospice services for patients with severe, life-limiting illnesses. This type of care is aimed at making the terminally ill patient's final days as comfortable and pain-free as possible. Hospice care is typically available to patients who have been initially certified as terminally ill (i.e., a prognosis of six months or less) by their attending physician, if any, and the hospice physician. VITAS offers all levels of hospice care in a given market, including routine home care, inpatient care and continuous care. Over 90% of VITAS' revenues are derived through Medicare and Medicaid reimbursement programs. - The Roto-Rooter segment provides repair and maintenance services to residential and commercial accounts using the Roto-Rooter registered service mark. Such services include plumbing and sewer, drain and pipe cleaning. They are delivered through company-owned and operated territories, independent contractor-operated territories and franchised locations. This segment also manufactures and sells products and equipment used to provide such services. - We report corporate administrative expenses and unallocated investing and financing income and expense not directly related to either segment as "Corporate". Corporate administrative expense includes the stewardship, accounting and reporting, legal, tax and other costs of operating a publicly held corporation. Corporate investing and financing income and expenses include the costs and income associated with corporate debt and investment arrangements. The vast majority of our service revenues and sales from continuing operations are generated from business within the United States. 17
Chemed Corporation and Subsidiary Companies Segment data for our continuing operations are set forth below (in thousands, except footnote data): For the Years Ended December 31, -------------------------------- 2005 2004 2003 -------- -------- -------- REVENUES BY TYPE OF SERVICE VITAS Routine homecare $436,596 $317,010 $ -- Continuous care 106,417 78,669 -- General inpatient 86,127 63,051 -- -------- -------- -------- Total segment 629,140 458,730 -- -------- -------- -------- Roto-Rooter Sewer and drain cleaning 116,918 111,867 106,127 Plumbing repair and maintenance 118,625 107,642 101,590 Industrial and municipal sewer and drain cleaning 17,420 16,075 15,581 Contractors 18,070 16,360 14,125 HVAC repair and maintenance 3,624 3,111 3,044 Other products and services 22,680 21,556 20,309 -------- -------- -------- Total segment 297,337 276,611 260,776 -------- -------- -------- Total service revenues and sales $926,477 $735,341 $260,776 ======== ======== ======== AFTERTAX SEGMENT EARNINGS/ (LOSS) (A) (B) (C) VITAS $ 33,587 $ 29,139 $ -- Roto-Rooter 26,960 18,795 13,176 -------- -------- -------- Total segment earnings 60,547 47,934 13,176 Corporate (22,842) (24,643) (2,910) Equity in VITAS earnings/(loss) -- (4,105) 922 Discontinued operations (1,888) 8,326 (14,623) -------- -------- -------- Net income/ (loss) $ 35,817 $ 27,512 $ (3,435) ======== ======== ======== INTEREST INCOME VITAS $ 2,804 $ 1,091 $ -- Roto-Rooter 2,391 1,180 863 -------- -------- -------- Subtotal 5,195 2,271 863 Corporate 1,809 1,403 2,155 Intercompany eliminations (4,794) (1,800) (595) -------- -------- -------- Total interest income $ 2,210 $ 1,874 $ 2,423 ======== ======== ======== (a) 2005 includes the estimated cost for the anticipated settlement of a lawsuit of $10,757,000 aftertax (VITAS), payouts under our 2002 Executive Long-term Incentive Plan ("LTIP") of $1,774,000 aftertax (Corporate), $1,043,000 aftertax (VITAS) and $617,000 aftertax (Roto-Rooter), the prepayment penalty incurred on the early extinguishment of debt of $2,523,000 aftertax (Corporate), a favorable adjustment of $1,014,000 aftertax (Roto-Rooter) for casualty insurance related to prior periods' experience, legal expenses of $397,000 aftertax (VITAS) incurred in connection with the Office of Inspector General ("OIG") investigation, additional favorable VITAS transaction adjustments of $961,000 aftertax (Corporate), the cost of accelerating vesting of stock options of $137,000 aftertax (Corporate) and favorable tax adjustments and settlements from prior year returns of $835,000 aftertax (Corporate) and $1,126,000 (Roto-Rooter). (b) 2004 includes payouts under our LTIP of $4,455,000 aftertax (Corporate) and $982,000 aftertax (Roto-Rooter), the prepayment penalty incurred on the early extinguishment of debt of $2,030,000 aftertax (Corporate), the estimated cost for the anticipated settlement of a lawsuit of $1,897,000 aftertax (Roto-Rooter), expenses related to debt registration of $727,000 aftertax (Corporate), our aftertax share of VITAS' charges related to the acquisition of VITAS amounting to $4,621,000 (Equity in VITAS earnings/(loss)), additional VITAS transaction costs and adjustments of a charge of $1,008,000 aftertax (VITAS) and a credit of $786,000 aftertax (Corporate), and favorable tax adjustments and settlements from prior year returns of $990,000 aftertax (Corporate) and $630,000 (Roto-Rooter). (c) 2003 includes severance charges of $2,358,000 aftertax (Corporate) and aftertax capital gains on the sales and redemption of investments (Corporate) amounting to $3,351,000. 18
Chemed Corporation and Subsidiary Companies For the Years Ended December 31, -------------------------------- 2005 2004 2003 -------- -------- -------- INTEREST EXPENSE VITAS $ 153 $ 128 $ -- Roto-Rooter 563 206 170 -------- -------- -------- Subtotal 716 334 170 Corporate 20,548 20,824 3,007 -------- -------- -------- Total interest expense $ 21,264 $ 21,158 $ 3,177 ======== ======== ======== INCOME TAX PROVISION (D) (E) VITAS $ 20,394 $ 20,030 $ -- Roto-Rooter 15,635 10,611 8,054 -------- -------- -------- Subtotal 36,029 30,641 8,054 Corporate (16,451) (16,845) (1,874) -------- -------- -------- Total income tax provision $ 19,578 $ 13,796 $ 6,180 ======== ======== ======== IDENTIFIABLE ASSETS VITAS $532,299 $502,810 $ -- Roto-Rooter 179,063 174,310 172,257 -------- -------- -------- Total identifiable assets 711,362 677,120 172,257 Corporate (f) 123,723 129,344 129,664 Discontinued operations -- 19,102 26,537 -------- -------- -------- Total assets $835,085 $825,566 $328,458 ======== ======== ======== ADDITIONS TO LONG-LIVED ASSETS (G) VITAS $ 24,462 $434,509 $ -- Roto-Rooter 7,938 8,690 12,610 -------- -------- -------- Subtotal 32,400 443,199 12,610 Corporate (f) 443 785 1,621 -------- -------- -------- Total additions $ 32,843 $443,984 $ 14,231 ======== ======== ======== DEPRECIATION AND AMORTIZATION (H) VITAS $ 11,932 $ 9,061 $ -- Roto-Rooter 8,361 8,702 9,481 -------- -------- -------- Subtotal 20,293 17,763 9,481 Corporate 1,208 558 340 -------- -------- -------- Total depreciation and amortization $ 21,501 $ 18,321 $ 9,821 ======== ======== ======== (d) 2005 includes favorable tax adjustments and settlements from prior year returns of $835,000 (Corporate) and $1,126,000 (Roto-Rooter). (e) 2004 includes favorable tax adjustments and settlements from prior year returns of $990,000 (Corporate) and $630,000 (Roto-Rooter). (f) Corporate assets consist primarily of cash and cash equivalents, marketable securities, properties and equipment and other investments. (g) Long-lived assets include goodwill, identifiable intangible assets and property and equipment. (h) Depreciation and amortization include amortization of identifiable, definite-lived intangible assets and stock awards. 3. EQUITY INTEREST IN AFFILIATE (VITAS) Until February 23, 2004, we held a 37% interest in privately held VITAS. On August 18, 2003, VITAS retired our investment in the 9% Redeemable Preferred Stock of VITAS. Cash proceeds to us totaled $27.3 million, and we realized a pretax gain of $1.8 million ($1.2 million aftertax) on the redemption of preferred stock in the third quarter of 2003. During 2003, the dividends and amortization of preferred stock discount on this investment contributed $1.6 million to our aftertax earnings. On October 14, 2003, we exercised two of our three warrants to purchase 4,158,000 common shares of VITAS, or 37%, for $18 million in cash. See Note 7 regarding the acquisition of the 63% of VITAS we did not own in 2003. 19
Chemed Corporation and Subsidiary Companies During the period January 1 through February 23, 2004, VITAS recognized a net loss of $18.3 million due to the recognition of approximately $20.9 million of aftertax costs related to VITAS' sale of its business to us. Our aftertax share of VITAS' loss for this period was $ 4.1 million. Included in the aftertax costs related to VITAS' sale of its business are the following (in thousands): Accrual for potential severance costs under key employment agreements $10,975 Legal and valuation costs 6,665 Loss on write-off of VITAS' deferred debt issuance costs 2,698 Other 592 ------- Total $20,930 ======= 4. GOODWILL AND INTANGIBLE ASSETS Amortization of definite-lived intangible assets from continuing operations was (in thousands): For the Years Ended December 31, - -------------------------------- 2005 2004 2003 ------ ------ ---- $4,438 $3,468 $130 The following is a schedule by year of projected amortization expense for definite-lived intangible assets (in thousands): 2006 $4,412 2007 4,378 2008 4,371 2009 4,363 2010 3,788 The balance in identifiable intangible assets comprises the following (in thousands): Gross Accumulated Net Book Asset Amortization Value ------- ------------ -------- DECEMBER 31, 2005 REFERRAL NETWORKS $23,772 $(5,510) $18,262 COVENANTS NOT TO COMPETE 8,676 (3,236) 5,440 CUSTOMER LISTS 1,222 (866) 356 ------- ------- ------- SUBTOTAL - DEFINITE-LIVED INTANGIBLES 33,670 (9,612) 24,058 VITAS TRADE NAME 51,300 -- 51,300 ------- ------- ------- TOTAL $84,970 $(9,612) $75,358 ======= ======= ======= December 31, 2004 Referral network $20,900 $(2,348) $18,552 Covenants not to compete 8,676 (2,043) 6,633 Customer lists 1,222 (783) 439 ------- ------- ------- Subtotal - definite-lived intangibles 30,798 (5,174) 25,624 VITAS trade name 51,300 -- 51,300 ------- ------- ------- Total $82,098 $(5,174) $76,924 ======= ======= ======= 20
Chemed Corporation and Subsidiary Companies The changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2005 are as follows (in thousands): Roto- VITAS Rooter Total -------- -------- -------- December 31, 2003 $ -- $105,335 $105,335 Acquired in business combinations 324,330 2,918 327,248 Other adjustments -- 149 149 -------- -------- -------- DECEMBER 31, 2004 324,330 108,402 432,732 ACQUIRED IN BUSINESS COMBINATIONS 414 498 912 OTHER ADJUSTMENTS -- 112 112 -------- -------- -------- DECEMBER 31, 2005 $324,744 $109,012 $433,756 ======== ======== ======== We performed impairment tests of goodwill for all of our reporting units and for the VITAS trade name as of December 31, 2005 and 2004. For all reporting units included in continuing operations, these tests indicated that our goodwill and VITAS trade name are not impaired. For the purpose of impairment testing, we consider the reporting units to be VITAS, Roto-Rooter Services (plumbing and drain cleaning services) and Roto-Rooter Franchising and Products (franchising and manufacturing and sale of plumbing and drain cleaning products). Service America, which was reclassified to discontinued operations in 2004, recognized a goodwill impairment loss of $10.0 million in 2003 largely due to declining revenues and poor operating results for several years. 5. OTHER EXPENSES Other expenses from continuing operations include the following pretax charges (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 ------- ------- Long-term incentive compensation (Note 19) $ 5,477 $ 8,783 Accrual for lawsuit settlement (Note 22) 17,350 3,135 VITAS transaction costs and adjustments (Note 7) (961) 442 Cost of accelerating the vesting of outstanding stock options (Note 1) 215 -- Professional fees incurred to register Floating Rate Notes (Note 12) -- 1,191 ------- ------- Total other expenses $22,081 $13,551 ======= ======= 21
Chemed Corporation and Subsidiary Companies 6. DISCONTINUED OPERATIONS Discontinued operations comprise (in thousands, except per share amounts): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------ -------- Service America (2004): Income/(loss) before income taxes $ 576 $ (535) $(16,118) Income taxes (241) 222 1,431 ------- ------ -------- Income/(loss) from operations, net of income taxes 335 (313) (14,687) (Loss)/gain on disposal, net of income tax benefit of $165 and $14,230, respectively (2,148) 8,872 -- ------- ------ -------- Total Service America (1,813) 8,559 (14,687) ------- ------ -------- Adjustment to accruals of operations discontinued in prior years: Legal accruals (2002) (120) -- -- Environmental and sublease accruals (1991) -- (700) -- Allowance for uncollectible notes receivable and other accruals (2001) -- 383 99 ------- ------ -------- Gain/(loss) before income taxes (120) (317) 99 All other income taxes 45 84 (35) ------- ------ -------- Total adjustments (75) (233) 64 ------- ------ -------- Total discontinued operations $(1,888) $8,326 $(14,623) ======= ====== ======== Earnings/(loss) per share $ (0.08) $ 0.34 $ (0.73) ======= ====== ======== Diluted earnings/(loss) per share $ (0.07) $ 0.34 $ (0.73) ======= ====== ======== In December 2004, the Board of Directors authorized the discontinuance of our Service America segment through an asset sale to employees of Service America. The disposal was completed in May 2005. Our decision to dispose of Service America, which provides major-appliance and heating/air conditioning repair, maintenance and replacement services, was based on declining operating results and projected operating losses. The acquiring corporation purchased the substantial majority of Service America's assets in exchange for assuming substantially all of Service America's liabilities. The loss on disposal of Service America in 2005 arises from the finalization of asset and liability values and related tax benefits resulting from the consummation of the sale transaction. Included in the assets acquired is a receivable from us for approximately $4.7 million. We paid $1 million of the amount upon closing and the remainder is due over the following year in 11 equal installments. The balance due Service America as of December 31, 2005 is $1.3 million. We recognized a tax benefit of approximately $14.2 million on this disposal in 2004, primarily due to the recognition of non-deductible goodwill impairment losses in prior years. During 2004, we increased our accrual for environmental liabilities related to the disposal of DuBois Chemicals, Inc. ("DuBois") in 1991 by $700,000. The adjustment is based on an assessment by our environmental attorney and ongoing discussions with the U.S. Environmental Protection Agency. The $383,000 and $99,000 reductions to the allowance for uncollectible notes receivable from Cadre Computer Resources Co. ("Cadre Computer") (sold in 2001) in 2004 and 2003, respectively, are attributable to Cadre Computer's experiencing better-than-anticipated financial results and to the expiration of $350,000 of Cadre Computer's line of credit with us. We sold Patient Care to an investor group that included Schroder Ventures Life Sciences Group, Oak Investment Partners, Prospect Partners and Salix Ventures in 2002. We have a $12.5 million senior subordinated note receivable from Patient Care ("Note") due October 11, 2007, that bears interest at the annual rate of 7.5% through September 30, 2004, 8.5% from October 1, 2004 through September 30, 2005, and 9.5% thereafter. The Note is presented on a separate line in the consolidated balance sheet. At the time of sale, $5 million was placed in escrow and is subject to the collection of Patient Care's receivables with third-party payers. Of this amount, $2.5 million was distributed to us in October 2003 and $1.7 million was distributed to us in 2004. No amounts were distributed in 2005. The remaining $769,000 was withheld, pending settlement of a pre-acquisition receivable. Based on the previous collection experience of Patient Care, we expect to collect substantially all of the funds remaining in escrow. We also received a common stock purchase warrant that permits us to purchase up to 2% of Patient Care. The warrant was recorded at its estimated fair value on the date acquired and is included in other investments in the consolidated balance sheet. Patient Care has not provided us with financial statements since the first quarter of 2004. When, and if, the current Patient Care financial information is provided, it is 22
Chemed Corporation and Subsidiary Companies possible that we may have to recognize an impairment loss on our investment in Patient Care for all or a portion of the carrying value of the warrant. Our current receivables from Patient Care (total of $3.2 million at December 31, 2005) are currently in litigation in which Patient Care alleges our acquisition of VITAS violates a non-compete agreement. The sale and related non-compete agreement specifically exempt our investment in VITAS. Therefore, we believe our receivable is valid and their allegations have no merit. Revenues generated by discontinued operations comprise (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------- ------- Service America $10,716 $38,986 $48,095 At December 31, 2005, other current liabilities include accruals of $5.5 million and other liabilities include accruals of $2.1 million for costs related to discontinued operations. The estimated timing of payments of these liabilities, relating primarily to sublease and environmental liabilities, follows (in thousands): 2006 $5,533 2007 638 2008 522 2009 522 2010 337 AFTER 2010 59 ------ TOTAL $7,611 ====== Our Chairman of the Board, President and Chief Executive Officer and our former Chief Administrative Officer (currently a director of our company) are directors of Cadre Computer. In addition, our former Chief Administrative Officer holds a 51% equity ownership interest in Cadre Computer at December 31, 2005 and is Chairman and Chief Executive Officer of Cadre Computer. 7. BUSINESS COMBINATIONS During 2005, we completed one business combination within the Roto-Rooter segment and two within the VITAS segment for an aggregate purchase price of $6.2 million in cash. The acquisitions were completed mainly to increase our market penetration. The VITAS businesses acquired provide hospice services in the Pittsburgh, PA and Philadelphia, PA areas and the Roto-Rooter business acquired provides drain cleaning and plumbing services using the Roto-Rooter name in Greensboro, NC. The results of operations of these businesses are included in our results of operations from the date of acquisition. The purchase price allocations for the 2005 business combinations are preliminary and will be finalized during 2006. On February 24, 2004, we completed the acquisition of the 63% of VITAS common stock we did not previously own for cash consideration of $323.8 million. The total investment in VITAS, including $3.1 million of acquisition expenses and our $18.0 million prior investment in VITAS, was $366.2 million. We have completed the purchase price allocation and the excess of the purchase price over the fair value of the net assets acquired in purchase business combinations is classified as goodwill. 23
Chemed Corporation and Subsidiary Companies A summary of net assets acquired in the VITAS transaction follows (in thousands): Cash and cash equivalents $ 24,377 Accounts receivable, net 49,762 Current deferred income taxes 13,449 Prepaid income taxes 13,399 Other current assets 25,299 Property and equipment 19,073 VITAS trade name 51,300 Referral network 20,900 Covenants not to compete 7,600 Goodwill 306,298 Other assets 10,401 Accounts payable (40,554) Current portion of long-term debt (7,940) Accrued expenses (43,169) Long-term debt (59,571) Deferred income taxes (21,171) Other liabilities (3,259) -------- Total net assets 366,194 Less: prior investment in VITAS (18,032) Less-cash and cash equivalents acquired (24,377) -------- Net cash used $323,785 ======== We began including the consolidated VITAS results of operations in our financial statements as of February 24, 2004. To fund the acquisition and retire VITAS' and our long-term debt, we completed the following transactions on February 24, 2004: - We borrowed $75.0 million under a new $135 million revolving credit/term loan agreement at an initial weighted average interest rate of 4.5%. - We sold 4 million shares of our capital stock in a private placement at a price of $25 per share, before expenses. - We issued $110 million principal amount of floating rate senior secured notes due February 2010 at an initial interest rate of 4.88%. - We issued $150 million principal amount of 8.75% fixed rate senior notes due February 2011. - We incurred estimated financing and transaction fees and expenses of approximately $19.3 million. During 2004, we completed two business combinations within the Roto-Rooter segment and two within the VITAS segment for an aggregate purchase price of $20.9 million in cash. The VITAS businesses acquired provide hospice services in the Phoenix, AZ and the Atlanta, GA areas, and the Roto-Rooter businesses acquired provide drain cleaning and plumbing services using the Roto-Rooter name in Harrisburg, PA and Spokane, WA. The results of operations of all of these businesses are included in our results of operations from the date of acquisition. The purchase price allocation for the Phoenix, AZ hospice business was completed in the fourth quarter of 2005. In connection with the final purchase price allocation, an identifiable, definite-lived intangible asset of $2.9 million for the referral network acquired was recorded. The referral network acquired will be amortized on an accelerated basis over a nine year estimated useful life. A liability of $2.4 million was recorded based on the most recent estimate related to the Medicare cap liability for the 2005 measurement period, as further described in Note 1. The excess of the purchase price over the fair value of the net assets acquired in purchase business combinations is classified as goodwill. The purchase price of all businesses (except VITAS) acquired during the year indicated has been 24
Chemed Corporation and Subsidiary Companies allocated as follows (in thousands)(2005 is preliminary): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------ ------- ------ Working capital $ -- $ -- $ (114) Identifiable intangible assets 2,870 -- -- Goodwill 911 20,950 4,246 Other assets and liabilities-net 2,426 (8) (282) ------ ------- ------ Total net assets $6,207 $20,942 $3,850 ====== ======= ====== Approximately $20.9 million of the goodwill related to the VITAS acquisition and all of the goodwill related to business combinations completed in 2005, 2004 and 2003 is expected to be deductible for income tax purposes. The unaudited pro forma results of operations, assuming purchase business combinations completed in 2005 and 2004 were completed on January 1, 2004 are presented below (in thousands, except per share data): For the Years Ended December 31, -------------------------------- 2005 2004 -------- -------- Service revenues and sales $927,170 $820,315 Net income 35,854 34,508 Earnings per share 1.40 1.43 Diluted earnings per share 1.36 1.40 8. OTHER INCOME--NET Other income--net from continuing operations comprises the following (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------ ------ ------- Interest income $2,210 $1,874 $ 2,423 Market value gains on trading investments of employee benefit trusts 863 1,859 1,580 Loss on disposal of property and equipment (131) (350) (253) Dividend income -- -- 1,540 Gains on sales and redemption of investments -- -- 5,390 Other - net 192 86 169 ------ ------ ------- Total other income - net $3,134 $3,469 $10,849 ====== ====== ======= 25
Chemed Corporation and Subsidiary Companies 9. INCOME TAXES The provision for income taxes comprises the following (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 -------- -------- ------- Continuing Operations: Current U.S. federal $ 21,155 $ 7,065 $ 3,611 U.S. state and local 1,586 1,214 1,102 Foreign 519 515 253 Deferred U.S. federal, state and local (3,578) 5,093 1,230 Foreign (104) (91) (16) -------- -------- ------- Total $ 19,578 $ 13,796 $ 6,180 ======== ======== ======= Discontinued Operations: Current U.S. federal $(14,452) $ (2,373) $ (442) Current U.S. state and local (1,036) (60) 77 Deferred U.S. federal, state and local 15,519 (12,104) (1,031) -------- -------- ------- Total $ 31 $(14,537) $(1,396) ======== ======== ======= A summary of the significant temporary differences for continuing operations that give rise to deferred income tax assets/(liabilities) follows (in thousands): December 31, ------------------- 2005 2004 -------- -------- Accrued liabilities $ 34,661 $ 40,683 Allowance for uncollectible accounts receivable 2,952 2,715 State net operating loss carryforwards 1,878 2,671 Deferred financing costs 856 1,225 Other 1,671 1,672 -------- -------- Deferred income tax assets 42,018 48,966 Valuation allowance -- (1,403) -------- -------- Deferred income tax assets, net of valuation allowance 42,018 47,563 -------- -------- Amortization of intangible assets (26,357) (23,172) Accelerated tax depreciation (8,425) (6,746) Current assets (1,832) (1,906) Other (518) (949) -------- -------- Deferred income tax liabilities (37,132) (32,773) -------- -------- Net deferred income tax assets $ 4,886 $ 14,790 ======== ======== Included in other assets at December 31, 2005, are deferred income tax assets of $499,000 (December 31, 2004--$354,000). At December 31, 2005 and 2004, state net operating loss carryforwards were $39.6 million and $36.1 million, respectively. These net operating losses will expire, in varying amounts, between 2009 and 2025. Deferred income tax assets as of December 31, 2004 were reduced by a valuation allowance comprising 100% of the potential deferred tax benefits on net operating losses relating to the State of Ohio. As a result of the enactment of the Ohio CAT, which will preclude us from utilizing State of Ohio net operating losses, the deferred tax asset and related valuation allowance for the State of Ohio net operating losses were reversed as of December 31, 2005. Based on our history of operating earnings, we have determined that our operating income will, more likely than not, be sufficient to ensure realization of our deferred income tax assets, net of the valuation allowance. We believe no net operating losses will be lost due to the continuity of business requirement. 26
Chemed Corporation and Subsidiary Companies The difference between the actual income tax provision for continuing operations and the income tax provision calculated at the statutory U.S. federal tax rate is explained as follows (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------- ------ Income tax provision calculated using the statutory rate of 35% $20,049 $12,980 $5,756 State and local income taxes, less federal income tax effect 2,139 2,511 717 Tax accrual adjustments (2,403) (2,009) 102 Domestic dividend exclusion -- -- (441) Other--net (207) 314 46 ------- ------- ------ Income tax provision $19,578 $13,796 $6,180 ======= ======= ====== Effective tax rate 34.2% 37.2% 37.6% ======= ======= ====== Income tax benefits attributable to the exercise of non-qualified employee stock options were $10.8 million during the year ended December 31, 2005 (2004--$1.9 million; 2003--$960,000) and were credited directly to additional paid-in capital. Income taxes included in the components of other comprehensive income/(loss) are as follows (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ---- ---- ------- Unrealized holding losses $-- $-- $ (180) Reclassification adjustment -- -- (2,039) Summarized below are the total amounts of income taxes paid/(refunded) during the years ended December 31 (in thousands): 2005 $ 9,923 2004 (13,131) 2003 2,715 Provision has not been made for additional taxes on $35.1 million of undistributed earnings of our domestic subsidiaries. Should we elect to sell our interest in all of these businesses rather than to effect a tax-free liquidation, additional taxes amounting to approximately $12.8 million would be incurred based on current income tax rates. 10. CASH OVERDRAFTS AND CASH EQUIVALENTS Included in accounts payable are cash overdrafts of $8.0 million and $1.3 million as of December 31, 2005 and 2004, respectively. Included in cash and cash equivalents at December 31, 2005, are cash equivalents in the amount of $53.2 million (2004-$63.0 million). The cash equivalents at both dates consist of investments in various money market funds and repurchase agreements yielding interest at a weighted average rate of 4.1% in 2005 and 2.0% in 2004. From time to time throughout the year, we invest our excess cash in repurchase agreements directly with major commercial banks. We do not physically hold the collateral, but the term of such repurchase agreements is less than 10 days. Investments of significant amounts are spread among a number of banks, and the amounts invested in each bank are varied constantly. 27
Chemed Corporation and Subsidiary Companies 11. PROPERTIES AND EQUIPMENT A summary of properties and equipment follows (in thousands): December 31, ------------------- 2005 2004 -------- -------- Land $ 1,713 $ 1,713 Buildings 22,997 20,803 Transportation equipment 12,696 13,114 Machinery and equipment 40,452 36,290 Computer software 19,568 17,050 Furniture and fixtures 26,407 17,201 Projects under development 8,271 3,122 -------- -------- Total properties and equipment 132,104 109,293 Less accumulated depreciation (66,655) (53,497) -------- -------- Net properties and equipment $ 65,449 $ 55,796 ======== ======== 12. LONG-TERM DEBT AND LINES OF CREDIT A summary of our long-term debt follows (in thousands): December 31, ------------------- 2005 2004 -------- -------- Fixed rate notes due 2011 $150,000 $150,000 Floating rate notes due 2010 -- 110,000 Term loan due 2005 - 2009 84,363 30,487 Other 740 1,208 -------- -------- Subtotal 235,103 291,695 Less current portion (1,045) (12,185) -------- -------- Long-term debt, less current portion $234,058 $279,510 ======== ======== The average interest rate for our long-term debt was 7.5% and 7.0% for the years ended December 31, 2005 and 2004, respectively. 2005 CREDIT FACILITY In February 2005, we amended our bank credit facility with JPMorgan Chase Bank. The Amended and Restated Credit Agreement ("ARCA") provides for an increase in the term loan ("TL") from $35 million to $85 million at a current rate of LIBOR plus 2.0% and an increase of the revolving credit facility ("RCF") from $100 million to $175 million at a current rate of LIBOR plus 2.5%. The TL has 21 quarterly principal payments of $212,500, beginning on June 30, 2005, with the balance due August 24, 2010. The RCF has a termination date of February 24, 2010. Commitment fees include an annual fee of $100,000 plus a fee of .375% per annum of the unused RCF, payable quarterly. Loans under the ARCA are collateralized by substantially all of our assets. Should we generate excess cash flow ("ECF") during a year, as defined in ARCA, an additional principal payment must be made. Generally, ECF represents the excess of Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") less net working capital requirements, less income taxes paid, less capital expenditures, less interest expense, less principal payments on the TL, less cash used for acquisitions and less cash dividends paid. Based on our results as of and for the year ended December 31, 2005 and 2004, no additional term loan payments have been required. Also in February 2005, we used proceeds from borrowings under the ARCA ($85 million TL and $3.5 million RCF) plus $54.4 million of our cash balances to retire our previous term loan ($30.5 million), to redeem the entire $110 million aggregate principal amount of our Floating Rate Notes due 2010, to pay $1.1 million prepayment penalty for the Floating Rate Notes and to pay $1.4 million of fees for the ARCA. 28
Chemed Corporation and Subsidiary Companies 2004 CREDIT AGREEMENTS On February 24, 2004, in conjunction with our acquisition of the VITAS shares not previously owned, we retired our senior notes due 2005 through 2009 and canceled our revolving credit agreement with Bank One, N.A. ("Bank One"). To fund this acquisition and retire the Senior Notes, we issued 4 million shares of capital stock in a private placement and borrowed $335 million as follows: - $150 million from the issuance of privately placed 8.75% senior notes ("Fixed Rate Notes") due 2011. Semiannual interest payments began in August 2004 and payment of unpaid principal and interest will be due February 2011. The Fixed Rate Notes are unsecured and are effectively subordinated to our secured indebtedness. In the second quarter of 2004, we filed a registration statement covering up to $150 million principal amount of new 8.75% senior notes due 2011 ("New Fixed Rate Notes"). Except for the lack of transfer restrictions, the terms of the New Fixed Rate Notes are substantially identical to those of the Fixed Rate Notes. Pursuant to our exchange offer, all holders of the Fixed Rate Notes exchanged their notes for like principal amounts of the New Fixed Rate Notes. Prior to February 24, 2007, up to a maximum of 35% of the principal of the New Fixed Rate Notes may be redeemed under specified circumstances at a price of 108.75% plus accrued interest. After February 24, 2007, the New Fixed Rate Notes may be redeemed, in whole or in part, at redemption prices ranging from 104.375% (beginning on February 24, 2007) to 100% (beginning on February 24, 2010) plus accrued interest. - $110 million from the issuance of privately placed floating rate senior secured notes ("Floating Rate Notes") due 2010 which were redeemed in 2005. - $75 million drawn down under a $135 million secured revolving credit/term loan facility ("2004 Credit Facility") with JPMorgan Chase Bank. The facility comprised a $35 million term loan and $100 million revolving credit facility, including up to $40 million in letters of credit. This facility was replaced in 2005 with the ARCA. OTHER Other long-term debt has arisen from loans in connection with acquisitions of various businesses and properties. Interest rates range from 5% to 8%, and the obligations are due on various dates through December 2009. The following is a schedule by year of required long-term debt payments as of December 31, 2005 (in thousands): 2006 $ 1,045 2007 1,058 2008 1,009 2009 1,016 2010 862 AFTER 2010 230,113 -------- TOTAL LONG-TERM DEBT $235,103 ======== Summarized below are the total amounts of interest paid during the years ended December 31 (in thousands): 2005 $20,368 2004 17,255 2003 3,197 During 2005 and 2004, interest totaling $380,000 and $72,000, respectively, was capitalized. No interest was capitalized during the year ended December 31, 2003. DEBT COVENANTS Collectively, the ARCA and the New Fixed Rate Notes provide for affirmative and restrictive covenants including, without limitation, requirements or restrictions (subject to exceptions) related to the following: - use of proceeds of loans, - restricted payments, including payments of dividends and retirement of stock (permitting $.24 per share dividends so long as the aggregate amount of dividends in any fiscal year does not exceed $7.0 million), with exceptions for existing employee benefit plans and stock option plans, 29
Chemed Corporation and Subsidiary Companies - mergers and dissolutions, - sales of assets, - investments and acquisitions, - liens, - transactions with affiliates, - hedging and other financial contracts, - restrictions on subsidiaries, - contingent obligations, - operating leases, - guarantors, - collateral, - sale and leaseback transactions, - prepayments of indebtedness, - maximum annual limit for acquisitions of $80 million (no single acquisition to exceed $50 million), - maximum annual expenditures for operating leases of $30 million, and - maximum annual capital expenditures of $30 million. In addition, the credit agreements provide that the Company will be required to meet minimum net worth requirements, maximum leverage requirements, maximum senior leverage requirements and minimum fixed charge requirements, to be tested quarterly. The ARCA also contains cross-default provisions. We are in compliance with all debt covenants as of December 31, 2005. As of December 31, 2005, we have approximately $147 million of unused lines of credit available and eligible to be drawn down under the RCF. In connection with the February 2005 transaction, we recorded a loss on the extinguishment of debt of $4.0 million that comprised a prepayment penalty of $1.1 million on the Floating Rate Notes and the write-off of $2.9 million of unamortized debt issuance costs for the Floating Rate Notes and the previous term loan. In connection with the February 2004 transaction, we incurred a prepayment penalty of $3.3 million on the senior notes. 13. OTHER LIABILITIES At December 31, 2005 and 2004, other current liabilities comprised the following (in thousands): December 31, ----------------- 2005 2004 ------- ------- Accrued incentive compensation $ 9,719 $ 8,115 Accrued legal settlements 23,108 3,989 Accrued divestiture expenses 3,895 4,232 Accrued savings and retirement contribution 3,243 2,639 Other 21,497 23,802 ------- ------- Total other current liabilities $61,462 $42,777 ======= ======= At December 31, 2005 and 2004, the accrual for our estimated liability for potential environmental cleanup and related costs arising from the sale of DuBois amounted to $3.0 million. Of the 2005 balance, $1.1 million is included in other liabilities and $1.9 million is included in other current liabilities. We are contingently liable for additional DuBois-related environmental cleanup and related costs up to a maximum of $16 million. On the basis of a continuing evaluation of the potential liability, we believe it is not probable this additional liability will be paid. Accordingly, no provision for this contingent liability has been recorded. The potential liability is not insured, and the recorded liability does not assume the recovery of insurance proceeds. Also, the environmental liability has not been discounted because it is not possible to reliably project the timing of payments. We believe that any adjustments to our recorded liability will not materially adversely affect our financial position or results of operations. At December 31, 2005, our accrual for losses on subleases of office space formerly occupied by DuBois amounted to $388,000 (2004--$1.6 million), all of which is included in other current liabilities. The accrual is based on the expectation that space currently unoccupied will not be sublet during the remainder of the lease term, which ends April 2006. 30
Chemed Corporation and Subsidiary Companies 14. PENSION AND RETIREMENT PLANS Retirement obligations under various plans cover substantially all full-time employees who meet age and/or service eligibility requirements. The major plans providing retirement benefits to our employees are defined contribution plans. We established two employee stock ownership plans ("ESOPs") that purchased a total of $56.0 million of our capital stock. In December 1997, we restructured the ESOP loans and internally financed $16.2 million of the $21.8 million ESOP loans outstanding at December 31, 1997. Substantially all eligible employees of the Roto-Rooter segment and the Corporate Office participate in the ESOPs. Eligible employees are also covered by other defined contribution plans. Expenses charged to continuing operations for our retirement and profit-sharing plans, ESOPs, excess benefit plans and other similar plans comprise the following (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------ ------ Compensation cost of ESOPs $ 1,324 $1,811 $1,138 Pension, profit-sharing and other similar plans 9,004 5,639 3,674 ------- ------ ------ Total $10,328 $7,450 $4,812 ======= ====== ====== Dividends on ESOP shares used for debt service $ 122 $ 129 $ 138 ======= ====== ====== At December 31, 2005, there were 502,036 allocated shares (2004--487,434 shares) and no unallocated shares (2004--37,216 shares) in the ESOP trusts. As all shares have been allocated as of December 31, 2005, the ESOP trusts will be terminated and participant balances transferred to the retirement plan in the first quarter of 2006. We have excess benefit plans for key employees whose participation in the qualified plans is limited by U.S. Employee Retirement Income Security Act requirements. Benefits are determined based on theoretical participation in the qualified ESOPs. Prior to September 1, 1998, the value of these benefits was invested in shares of our stock and in mutual funds, which were held by grantor trusts. Currently, benefits are only invested in mutual funds, and participants are not permitted to diversify accumulated benefits in shares of our stock. Trust assets invested in shares of our stock are included in treasury stock, and the corresponding liability is included in a separate component of shareholders' equity. At December 31, 2005, these trusts held 133,870 shares or $2.4 million of our stock (December 31, 2004--136,626 shares or $2.4 million). The diversified assets of our excess benefit and deferred compensation plans, all of which are invested in either company-owned life insurance or various mutual funds, totaled $21.1 million at December 31, 2005 (December 31, 2004--$18.3 million). 15. LEASE ARRANGEMENTS We have operating leases that cover our corporate office headquarters, various warehouse and office facilities, office equipment and transportation equipment. The remaining terms of these leases range from one year to 14 years, and in most cases, we expect that these leases will be renewed or replaced by other leases in the normal course of business. We have no significant capital leases as of December 31, 2005 or 2004. The following is a summary of future minimum rental payments and sublease rentals to be received under operating leases that have initial or remaining noncancelable terms in excess of one year at December 31, 2005 (in thousands): 2006 $17,360 2007 13,514 2008 10,426 2009 8,978 2010 4,702 AFTER 2010 9,447 ------- TOTAL MINIMUM RENTAL PAYMENTS 64,427 LESS: MINIMUM SUBLEASE RENTALS (351) ------- NET MINIMUM RENTAL PAYMENTS $64,076 ======= 31
Chemed Corporation and Subsidiary Companies Total rental expense incurred under operating leases for continuing operations follows (in thousands): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------- ------- Total rental payments $17,027 $13,569 $ 5,776 Less sublease rentals (1,659) (1,640) (1,603) ------- ------- ------- Net rental expense $15,368 $11,929 $ 4,173 ======= ======= ======= 16. FINANCIAL INSTRUMENTS The following methods and assumptions are used in estimating the fair value of each class of our financial instruments: - For cash and cash equivalents, accounts receivable and accounts payable, the carrying amount is a reasonable estimate of fair value because of the liquidity and short-term nature of these instruments. - The carrying values of our investment in the Patient Care warrant and the Note receivable due from Patient Care are considered to be the best indicator of fair value available at the present time. Patient Care is privately held and we have been able to obtain only minimal current financial data since February 2004. In addition, we are currently in litigation with Patient Care over the collection of other amounts due us. Patient Care is current on its payments of interest on its note payable to us. Nonetheless, when additional information becomes available such data could indicate the fair value of these investments is less than their respective carrying values. It is also possible that such decline could be considered other than temporary. In those circumstances, a write down to fair value would be required. - For long-term debt, we calculated the fair value based either on market quotations received from financial institutions or discounted cash flow analysis. The estimated fair values of our financial instruments are as follows (in thousands): December 31, ----------------------------------------- 2005 2004 ------------------- ------------------- CARRYING FAIR Carrying Fair AMOUNT VALUE Amount Value -------- -------- -------- -------- Other investments-- Investment in Patient Care warrant $ 1,445 $ 1,445 $ 1,445 $ 1,445 Note receivable 12,500 12,500 12,500 12,500 -------- -------- -------- -------- Total other investments $ 13,945 $ 13,945 $ 13,945 $ 13,945 ======== ======== ======== ======== Long-term debt $235,103 $244,091 $291,695 $306,328 The chart below summarizes information with respect to available-for-sale securities sold during the year ended December 31, 2003 (in thousands): Proceeds from redemption and sales $31,763 Gross realized gains 7,157 Gross realized losses 1,767 There were no available for sale securities sold during the years ended December 31, 2005 or 2004. 32
Chemed Corporation and Subsidiary Companies 17. EARNINGS/(LOSS) PER SHARE The computation of earnings/(loss) per share follows: Income from Continuing Operations Net Income/(Loss) --------------------------------- ---------------------------- Income Income Income Shares Per Share Income Shares Per Share ------- ------ --------- ------- ------ --------- 2005 Earnings $37,705 25,552 $1.48 $35,817 25,552 $ 1.40 ===== ====== Dilutive stock options -- 666 -- 666 Nonvested stock awards -- 81 -- 81 ------- ------ ------- ------ Diluted earnings $37,705 26,299 $1.43 $35,817 26,299 $ 1.36 ======= ====== ===== ======= ====== ====== 2004 Earnings $19,186 24,120 $0.80 $27,512 24,120 $ 1.14 ===== ====== Dilutive stock options -- 502 -- 502 Nonvested stock awards -- 14 -- 14 ------- ------ ------- ------ Diluted earnings $19,186 24,636 $0.78 $27,512 24,636 $ 1.12 ======= ====== ===== ======= ====== ====== 2003 Earnings/(loss) $11,188 19,848 $0.56 $(3,435) 19,848 $(0.17) ===== ====== Dilutive stock options -- 60 -- 60 ------- ------ ------- ------ Diluted earnings/(loss) $11,188 19,908 $0.56 $(3,435) 19,908 $(0.17) ======= ====== ===== ======= ====== ====== The impact of the CJSDs was excluded from the above computations in 2004 and 2003 because it was antidilutive to earnings per share for all periods. All of the remaining CJSDs were either converted or retired as of May 18, 2004. The debentures were convertible into an average of 274,000 shares for the year ended December 31, 2004 (2003--766,000). During 2003, certain stock options, whose exercise prices were greater than the average market price during most of the year, were excluded from the computation of diluted earnings per share. Those options comprise the following: Exercise Number of Grant Date Price Shares - ---------- -------- --------- May 2002 $18.45 513,600 March 1998 19.57 261,400 May 1996 19.38 235,250 April 1998 20.27 24,000 --------- Total 1,034,250 ========= During 2005 and 2004, there were no options outstanding whose exercise price exceeded the average market price for the year. 18. STOCK INCENTIVE PLANS We have eight Stock Incentive Plans under which 7,700,000 shares of our stock are issued to key employees pursuant to the grant of stock awards and/or options to purchase such shares. All options granted under these plans provide for a purchase price equal to the market value of the stock at the date of grant. The latest plan, covering a total of 1,400,000 shares, was adopted in May 2004. The stock option plans are not qualified, restricted or incentive stock option plans under the Internal Revenue Code. Options granted under these plans prior to 2004 generally become exercisable in four annual installments commencing six months after the date of grant. Options granted in 2004 generally become exercisable in full six months after the date of grant. As discussed in Note 1, options granted in 2005 became immediately exercisable along with any other unvested options. Under one plan, originally adopted in 1999, up to 500,000 shares may be issued to employees who are not our officers or directors. 33
Chemed Corporation and Subsidiary Companies Data relating to our stock issued to employees is as follows: 2005 2004 2003 --------------------- -------------------- -------------------- NUMBER WEIGHTED Number Weighted Number Weighted OF AVERAGE of Average of Average SHARES PRICE Shares Price Shares Price ---------- -------- --------- -------- --------- -------- Stock options: Outstanding at January 1 2,662,804 $19.34 2,345,730 $17.96 2,487,200 $17.75 Granted 346,600 38.11 803,068 22.32 482,200 17.93 Exercised (1,243,571) 18.67 (463,994) 17.63 (490,368) 16.55 Forfeited (24,000) 17.97 (22,000) 17.76 (600) 14.28 Expired -- -- -- -- (132,702) 19.12 ---------- --------- --------- Outstanding at December 31 1,741,833 23.57 2,662,804 19.34 2,345,730 17.96 ========== ========= ========= Exercisable at December 31 1,741,833 23.57 2,295,322 19.53 1,720,374 17.90 ========== ========= ========= Stock awards issued 147,619 43.27 296,712 26.38 9,212 17.36 ========== ========= ========= Options outstanding at December 31, 2005, comprise the following: Range of Exercise Prices ----------------------------------- $16.10 to $21.78 $25.39 to $41.55 ---------------- ---------------- Options outstanding 1,331,233 410,600 Average exercise price of options outstanding $ 19.63 $ 36.32 Average contractual life 6.2 yrs. 9.1 yrs. Options exercisable 1,331,233 410,600 Average exercise price of options exercisable $ 19.63 $ 36.32 There were 138,623 shares available for granting of stock options and awards at December 31, 2005. In March 2005, the Board of Directors approved immediate vesting of all unvested stock options to avoid recognizing approximately $951,000 of pretax expense that would have been charged to income under SFAS No. 123R. The $215,000 pretax charge for accelerating the vesting of these options is included in operating income for the year ended December 31, 2005. Total compensation cost recognized for stock awards for continuing operations was $5.7 million in 2005 (2004--$6.0 million; 2003--$147,000). The shares of stock were issued to key employees and directors at no cost and generally are restricted as to the transfer of ownership. During 1999, we purchased 203,000 shares of our stock in open-market transactions and sold these shares to certain employees at fair market value in exchange for interest-bearing recourse notes secured by the shares. Interest rates on these notes are set at the beginning of each year based on rates used by the Internal Revenue Service for demand loans (2.81% for 2005; 1.70% for 2004; and 1.80% for 2003). The notes receivable have no maturity date but become immediately due and payable at our option upon the occurrence of any of the following: (a) we, as noteholder, deem ourselves inadequately secured, (b) the death, insolvency, assignment for the benefit of creditors, or the commencement of any bankruptcy or insolvency proceedings of, or against, the employee, (c) any attempted transfer by the employee of the shares of stock purchased by the employee with the notes, or (d) termination of employment. The terms of the notes receivable place restrictions upon the sale of the underlying shares of stock, but the shares of stock are not physically restricted from sale. Should we demand payment of the notes and the value of the underlying shares is insufficient to satisfy the remaining liability, the employee would be required to pay us the difference in cash. 34
Chemed Corporation and Subsidiary Companies Activity in the notes receivable accounts, which are presented as a reduction of stockholders' equity in the consolidated balance sheet, is summarized below (in thousands): Balance at December 31, 2002 $ 952 Accrual of interest 16 Cash payments (11) Value of shares surrendered (23) ----- Balance at December 31, 2003 934 Accrual of interest 10 Cash payments (391) Value of shares surrendered (9) ----- BALANCE AT DECEMBER 31, 2004 544 ACCRUAL OF INTEREST 15 VALUE OF SHARES SURRENDERED (10) ----- BALANCE AT DECEMBER 31, 2005 $ 549 ===== Shares surrendered in payment of notes receivable are valued at their fair market value on the date of surrender. 19. EXECUTIVE LONG-TERM INCENTIVE PLAN In May 2002, our shareholders approved the adoption of the LTIP covering our officers and key employees. The LTIP is administered by the Compensation/Incentive Committee ("CIC") of the Board of Directors and was adopted to replace the restricted stock program, which was terminated at the end of 2001. Based on guidelines established by the CIC, the LTIP covers the granting of cash and stock awards based on two independent elements: 1) a totally discretionary award based on our operating performance covering a period greater than one year and less than four years and 2) an award based on the attainment of a target stock price of $25 per share during 10 consecutive trading days prior to the fourth anniversary of the plan. During January 2004, the price of our stock exceeded $25 per share for more than 10 consecutive trading days. In February 2004, the CIC approved a payout under the LTIP in the aggregate amount of $7.8 million ($2.8 million in cash and 169,266 shares of capital stock). The pretax expense of this award, including payroll taxes and benefit costs, totaled $9.1 million. Of this amount, $8.8 million relates to continuing operations and is included in other expenses for 2004 ($5.4 million aftertax). During June 2004, the CIC approved guidelines covering the establishment of a pool of 250,000 capital shares ("2004 LTIP Pool") to be distributed to eligible members of management upon attainment of the following hurdles during the period January 1, 2004 through December 31, 2007: - 88,000 shares will be awarded if our cumulative pro forma adjusted EBITDA (including the results of VITAS beginning January 1, 2004) reaches $365 million within the four-year period. - 88,000 shares will be awarded if our stock price reaches the following hurdles during any 30 trading days out of any 60-trading-day period during the four-year period: - 22,000 shares for a stock price of $35.00. - an additional 33,000 shares for a stock price of $38.75. - an additional 33,000 shares for a stock price of $42.50. - 44,000 shares represent a retention element, subject to a four-year, time-based vesting. - 30,000 shares may be awarded at the discretion of the CIC. On June 22, 2004, the CIC awarded 44,000 restricted shares of stock to key employees under the retention component of the 2004 LTIP Pool. These shares vest on December 31, 2007, for all participants still employed by us. The total cost of these awards is $1.1 million, based on the fair value of the stock on June 22, 2004. Of this amount, $1.0 million relates to continuing operations and is being amortized on a straight-line basis over the 42-month period ending December 31, 2007. During the first quarter of 2005, the price of our stock exceeded $35 per share for 30 trading days, fulfilling one of the performance targets set forth in the LTIP. On March 11, 2005, the CIC approved a payout of 25,000 shares of capital stock under the LTIP. The pretax expense of this award from continuing operations, including payroll taxes and benefit costs, was $1.1 million ($695,000 aftertax). During the second quarter of 2005, the price of our stock exceeded $38.75 per share for 30 trading days, fulfilling one of the performance targets set forth in the LTIP. On July 11, 2005, the CIC approved a payout of 37,500 shares of 35
Chemed Corporation and Subsidiary Companies capital stock under the LTIP. The pretax expense of this award from continuing operations, including payroll taxes and benefit costs, was $1.8 million ($1.2 million aftertax). During the fourth quarter of 2005, the price of our stock exceeded $42.50 per share for 30 trading days, fulfilling one of the performance requirements set forth in the LTIP. On December 2, 2005, the CIC approved a payout of 43,500 shares of capital stock under the LTIP. The pretax expense of this award from continuing operations, including payroll taxes and benefit costs, was $2.5 million ($1.6 million aftertax). As of December 31, 2005, no accrual for the cost of possible awards under the remaining components of the 2004 LTIP Pool was made since it was not probable at that time any of the awards would be earned and paid. As of December 31, 2005, a total of 100,000 shares may be earned under the EBITDA and contingent hurdles of the 2004 LTIP pool. 20. CONVERTIBLE JUNIOR SUBORDINATED DEBENTURES Effective February 1, 2000, we completed an Exchange Offer whereby stockholders exchanged 1,151,006 shares of capital stock for shares of Preferred Securities of the wholly owned Chemed Capital Trust ("CCT") on a one-for-one basis. On April 7, 2004, we announced the call of all Preferred Securities outstanding as of May 18, 2004, at face value ($27.00 per security) plus accrued dividends ($.35 per security). As a result, during the second quarter of 2004, 417,256 Preferred Securities were redeemed for 609,194 shares of stock and 101,282 Preferred Securities were redeemed for $2.7 million in cash. As a result, at December 31, 2004, there are no CJSDs or Preferred Securities outstanding. The number of Preferred Securities purchased and converted and shares of capital stock issued upon conversion are summarized below: For the Years Ended December 31, --------------- 2004 2003 ------- ----- Preferred Securities purchased 101,282 -- Preferred Securities converted 422,002 2,229 Shares of Capital Stock issued upon conversion of Preferred Securities 615,958 3,252 21. LOANS RECEIVABLE FROM INDEPENDENT CONTRACTORS At December 31, 2005, we had contractual arrangements with 59 independent contractors to provide plumbing repair and drain cleaning services under sublicensing agreements using the Roto-Rooter name in lesser-populated areas of the United States and Canada. The arrangements give the independent contractors the right to conduct a plumbing and drain cleaning business using the Roto-Rooter name in a specified territory in exchange for a royalty based on a percentage of cash labor sales, generally approximately 40%. We also pay for yellow pages advertising in these areas, provide certain capital equipment and provide operating manuals to be used as guidelines for operating a plumbing and drain cleaning business. The contracts are generally cancelable upon 90 days' written notice (without cause) or upon a few days' notice (with cause). The independent contractors are responsible for running the businesses as they believe best. Our maximum exposure to loss from arrangements with our independent contractors at December 31, 2005, is approximately $2.6 million ($2.8 million at December 31, 2004). The exposure to loss is mainly the result of loans given to the independent contractors. In most cases, these loans are partially secured by equipment owned by the independent contractor. The interest rates on the loans range from zero to 8% per annum, and the remaining terms of the loans range from 2.5 months to 5.5 years at December 31, 2005. During 2005, we recorded revenues of $18.1 million (2004--$16.4 million; 2003--$14.1 million) and pretax profits of $6.0 million (2004--$5.1 million; 2003--$4.4 million) from all of our independent contractors. 22. LITIGATION We are party to a class action lawsuit filed in the Third Judicial Circuit Court of Madison County, Illinois in June of 2000 by Robert Harris, alleging certain Roto-Rooter plumbing was performed by unlicensed employees. We contest these allegations and believe them without merit. Plaintiff moved for certification of a class of customers in 32 states who allegedly paid for plumbing work performed by unlicensed employees. Plaintiff also moved for partial summary judgment on grounds the licensed apprentice plumber who installed his faucet did not work under the direct personal supervision of a licensed master plumber. On June 19, 2002, the trial judge certified an Illinois-only plaintiffs class and granted summary judgment for the named party Plaintiff on the issue of liability, finding violation of the Illinois Plumbing License Act and the Illinois Consumer Fraud Act through Roto-Rooter's representation of the licensed apprentice as a plumber. The court has not ruled on certification of a class in the remaining 31 states. In December 2004, we reached a resolution of this matter 36
Chemed Corporation and Subsidiary Companies with the Plaintiff. This proposed settlement has been preliminarily approved by the court. We expect the parties to request final approval during 2006. We accrued $3.1 million in 2004 as the anticipated cost of settling this litigation. Like other large California employers, our VITAS subsidiary faces allegations of purported class-wide wage and hour violations. It is party to a class action lawsuit filed in the Superior Court of California, Los Angeles County, in April of 2004 by Ann Marie Costa, Ana Jimenez, Mariea Ruteaya and Gracetta Wilson. This case alleges failure to pay overtime wages for hours worked "off the clock" on administrative tasks, including voicemail retrieval, time entry, travel to and from work, and pager response. This case also alleges VITAS failed to provide meal and break periods to a purported class of California nurses, home health aides and licensed clinical social workers. The case also seeks payment of penalties, interest, and Plaintiffs' attorney fees. VITAS contested these allegations. Plaintiff moved for class certification, and VITAS opposed this motion. We have reached an agreement, which is subject to court approval, with the Plaintiff class in order to avoid the uncertainty of litigation and the diversion of resources and personnel resulting from the litigation. In connection with our acquisition of VITAS in February 2004, we recorded a liability of $2.3 million on VITAS' opening balance sheet for this case. At that time, this represented our best estimate of our exposure in the matter. As a result of the tentative resolution, we recorded a pretax charge of $17.4 million ($10.8 million aftertax), representing the portion of this settlement not accounted for on Vitas' opening balance sheet. These amounts are inclusive of Plaintiffs' class attorneys' fees and the costs of settlement administration. In the normal course of business, we are a party to various claims and legal proceedings. We record a reserve for these matters when an adverse outcome is probable and the amount of the potential liability is reasonably estimable. 23. OIG INVESTIGATION On April 7, 2005, we announced the Office of Inspector General ("OIG") for the Department of Health and Human Services served VITAS with civil subpoenas relating to VITAS' alleged failure to appropriately bill Medicare and Medicaid for hospice services. As part of this investigation, the OIG selected medical records for 320 past and current patients from VITAS' three largest programs for review. It also sought policies and procedures dating back to 1998 covering admissions, certifications, recertifications and discharges. During the third quarter of 2005, the OIG requested additional information from us. The U.S. Attorney General has since provided us with a copy of a qui tam complaint filed under seal in U.S. District Court for the Southern District of Florida. The complaint and all filings in the qui tam action remain under seal. We are conferring with the U.S. Attorney regarding our defenses to the complaint allegations. The U.S. Attorney has not decided whether to intervene in the qui tam action. We have incurred pretax expense related to complying with OIG requests of $637,000 for the year ended December 31, 2005. The government continues to investigate the complaint's allegations. We are unable to predict the outcome of this matter or the impact, if any, that the investigation may have on the business, results of operations, liquidity or capital resources. Regardless of outcome, responding to the subpoenas can adversely affect us through defense costs, diversion of our time and related publicity. 24. RELATED PARTY TRANSACTIONS In October 2004, VITAS entered into a pharmacy services agreement ("Agreement") with Omnicare, Inc. ("OCR") whereby OCR will provide specified pharmacy services for VITAS and its hospice patients in geographical areas served by both VITAS and OCR. The Agreement has an initial term of three years that renews automatically thereafter for one-year terms. Either party may cancel the Agreement at the end of said term. Under the Agreement, VITAS made purchases of $16.2 million and $344,000 from OCR during 2005 and 2004, respectively. Mr. E. L. Hutton is nonexecutive Chairman of the Board and a director of Chemed and of OCR. Mr. Joel F. Gemunder, President and Chief Executive Officer of OCR, Mr. Charles H. Erhart and Ms. Sandra E. Laney are directors of both Chemed and OCR. Mr. Kevin J. McNamara, our President, Chief Executive Officer and director, is a director emeritus of OCR. Nonetheless, we believe that the terms of the Agreement are no less favorable to VITAS than we could negotiate with an unrelated party. 25. CAPITAL STOCK SPLIT On March 11, 2005, the Board of Directors approved a 2-for-1 stock split in the form of a 100% stock dividend to shareholders of record at the close of business on April 22, 2005. The stock split was paid May 11, 2005. Under Delaware law, the par value of the stock remained $1 per share. Prior period share and per share data has been restated to retroactively reflect the impact of the stock split. The shares outstanding and in treasury reflected on the balance sheet prior to May 11, 2005 have not been restated. 37
UNAUDITED SUMMARY OF QUARTERLY RESULTS Chemed Corporation and Subsidiary Companies (in thousands, except per share data) FIRST SECOND THIRD FOURTH TOTAL FOR THE YEAR ENDED DECEMBER 31, 2005 QUARTER QUARTER QUARTER QUARTER YEAR - ------------------------------------ -------- -------- -------- -------- -------- CONTINUING OPERATIONS TOTAL SERVICE REVENUES AND SALES ........ $218,637 $226,309 $233,328 $248,203 $926,477 ======== ======== ======== ======== ======== GROSS PROFIT ............................ $ 65,685 $ 65,189 $ 68,099 $ 75,663 $274,636 ======== ======== ======== ======== ======== INCOME FROM OPERATIONS .................. $ 22,654 $ 22,062 $ 24,472 $ 10,196 $ 79,384 INTEREST EXPENSE ........................ (5,835) (5,039) (5,147) (5,243) (21,264) LOSS ON EXTINGUISHMENT OF DEBT .......... (3,971) -- -- -- (3,971) OTHER INCOME--NET ....................... 727 600 1,317 490 3,134 -------- -------- -------- -------- -------- INCOME BEFORE INCOME TAXES ........... 13,575 17,623 20,642 5,443 57,283 INCOME TAXES ............................ (5,670) (6,512) (6,010) (1,386) (19,578) -------- -------- -------- -------- -------- INCOME FROM CONTINUING OPERATIONS (A) ... 7,905 11,111 14,632 4,057 37,705 DISCONTINUED OPERATIONS .................... 211 (2,226) -- 127 (1,888) -------- -------- -------- -------- -------- NET INCOME (A) ............................. $ 8,116 $ 8,885 $ 14,632 $ 4,184 $ 35,817 ======== ======== ======== ======== ======== EARNINGS PER SHARE (A) INCOME FROM CONTINUING OPERATIONS ....... $ 0.31 $ 0.44 $ 0.57 $ 0.16 $ 1.48 ======== ======== ======== ======== ======== NET INCOME .............................. $ 0.32 $ 0.35 $ 0.57 $ 0.16 $ 1.40 ======== ======== ======== ======== ======== DILUTED EARNINGS PER SHARE (A) INCOME FROM CONTINUING OPERATIONS ....... $ 0.31 $ 0.42 $ 0.55 $ 0.15 $ 1.43 ======== ======== ======== ======== ======== NET INCOME .............................. $ 0.31 $ 0.34 $ 0.55 $ 0.16 $ 1.36 ======== ======== ======== ======== ======== AVERAGE NUMBER OF SHARES OUTSTANDING EARNINGS PER SHARE ...................... 25,152 25,489 25,719 25,858 25,552 ======== ======== ======== ======== ======== DILUTED EARNINGS PER SHARE .............. 25,910 26,214 26,401 26,590 26,299 ======== ======== ======== ======== ======== - ---------- (A) THE FOLLOWING AMOUNTS ARE INCLUDED IN INCOME FROM CONTINUING OPERATIONS DURING THE RESPECTIVE QUARTER (IN THOUSANDS): FIRST SECOND THIRD FOURTH TOTAL QUARTER QUARTER QUARTER QUARTER YEAR ------- ------- ------- ------- ------- PRETAX COST/(BENEFIT): LONG-TERM INCENTIVE PLAN PAYOUT $ 1,109 $1,837 $ -- $ 2,531 $ 5,477 PROPOSED SETTLEMENT OF LAWSUIT -- -- -- 17,350 17,350 LEGAL EXPENSES INCURRED IN CONNECTION WITH THE OFFICE OF INSPECTOR GENERAL INVESTIGATION -- 254 310 73 637 ADJUSTMENT TO CASUALTY INSURANCE RELATED TO PRIOR PERIODS EXPERIENCE (1,663) -- -- -- (1,663) PREPAYMENT PENALTY AND WRITE-OFF OF DEBT ISSUANCE COSTS RELATED TO EARLY EXTINGUISHMENT AND REFINANCING OF DEBT 3,971 -- -- -- 3,971 ADJUSTMENT OF TRANSACTION-RELATED EXPENSES OF THE VITAS ACQUISITION -- (671) (130) (160) (961) COST OF ACCELERATING VESTING OF STOCK OPTIONS 215 -- -- -- 215 ------- ------ ------- ------- ------- TOTAL $ 3,632 $1,420 $ 180 $19,794 $25,026 ======= ====== ======= ======= ======= AFTERTAX COST/(BENEFIT): LONG-TERM INCENTIVE PLAN PAYOUT $ 695 $1,152 $ -- $ 1,587 $ 3,434 PROPOSED SETTLEMENT OF LAWSUIT -- -- -- 10,757 10,757 LEGAL EXPENSES INCURRED IN CONNECTION WITH THE OFFICE OF INSPECTOR GENERAL INVESTIGATION -- 160 192 45 397 ADJUSTMENT TO CASUALTY INSURANCE RELATED TO PRIOR PERIODS EXPERIENCE (1,014) -- -- -- (1,014) PREPAYMENT PENALTY AND WRITE-OFF OF DEBT ISSUANCE COSTS RELATED TO EARLY EXTINGUISHMENT AND REFINANCING OF DEBT 2,523 -- -- -- 2,523 TAX ADJUSTMENTS AND SETTLEMENTS FROM PRIOR YEAR RETURNS -- -- (1,787) (174) (1,961) ADJUSTMENT OF TRANSACTION-RELATED EXPENSES OF THE VITAS ACQUISITION -- (671) (130) (160) (961) COST OF ACCELERATING VESTING OF STOCK OPTIONS 137 -- -- -- 137 ------- ------ ------- ------- ------- TOTAL $ 2,341 $ 641 $(1,725) $12,055 $13,312 ======= ====== ======= ======= ======= 38
UNAUDITED SUMMARY OF QUARTERLY RESULTS Chemed Corporation and Subsidiary Companies (in thousands, except per share data) First Second Third Fourth Total For the Year Ended December 31, 2004 Quarter Quarter Quarter Quarter Year - ------------------------------------ -------- -------- -------- -------- -------- Continuing Operations Total service revenues and sales ............... $120,340 $199,135 $201,885 $213,981 $735,341 ======== ======== ======== ======== ======== Gross profit ................................... $ 41,491 $ 59,065 $ 59,755 $ 67,952 $228,263 ======== ======== ======== ======== ======== Income from operations ......................... $ 974 $ 20,763 $ 20,289 $ 16,080 $ 58,106 Interest expense ............................... (2,900) (6,204) (6,083) (5,971) (21,158) Loss on extinguishment of debt ................. (3,330) -- -- -- (3,330) Other income--net .............................. 1,479 149 336 1,505 3,469 -------- -------- -------- -------- -------- Income/(loss) before income taxes ........... (3,777) 14,708 14,542 11,614 37,087 Income taxes ................................... 626 (6,381) (3,805) (4,236) (13,796) Equity in loss of affiliate .................... (4,105) -- -- -- (4,105) -------- -------- -------- -------- -------- Income/(loss) from continuing operations (a) ... (7,256) 8,327 10,737 7,378 19,186 Discontinued Operations ........................... 146 (9) (125) 8,314 8,326 -------- -------- -------- -------- -------- Net Income/(Loss) (a) ............................. $ (7,110) $ 8,318 $ 10,612 $ 15,692 $ 27,512 ======== ======== ======== ======== ======== Earnings/(Loss) Per Share (a) Income/(loss) from continuing operations ....... $ (0.33) $ 0.34 $ 0.43 $ 0.30 $ 0.80 ======== ======== ======== ======== ======== Net income/(loss) .............................. $ (0.33) $ 0.34 $ 0.43 $ 0.63 $ 1.14 ======== ======== ======== ======== ======== Diluted Earnings/(Loss) Per Share (a) Income/(loss) from continuing operations ....... $ (0.33) $ 0.33 $ 0.42 $ 0.29 $ 0.78 ======== ======== ======== ======== ======== Net income/(loss) .............................. $ (0.33) $ 0.33 $ 0.42 $ 0.61 $ 1.12 ======== ======== ======== ======== ======== Average number of shares outstanding Earnings/(loss) per share ...................... 21,824 24,650 24,940 24,994 24,120 ======== ======== ======== ======== ======== Diluted earnings/(loss) per share .............. 21,824 25,354 25,402 25,672 24,636 ======== ======== ======== ======== ======== - ---------- (a) The following amounts are included in income/(loss) from continuing operations during the respective quarter (in thousands): First Second Third Fourth Total Quarter Quarter Quarter Quarter Year ------- ------- ------- ------- -------- Pretax cost/(benefit): Long-term incentive plan payout $ 8,783 $ -- $ -- $ -- $ 8,783 Proposed settlement of a lawsuit -- -- -- 3,135 3,135 Prepayment penalty and write-off of debt issuance costs related to early extinguishment and refinancing of debt 3,330 -- -- -- 3,330 Expenses related to debt registration -- -- -- 1,191 1,191 Adjustment of transaction-related expenses of the VITAS acquisition -- (1,368) (219) 2,029 442 ------- ------- ------- ------ -------- Total $12,113 $(1,368) $ (219) $6,355 $ 16,881 ======= ======= ======= ====== ======== Aftertax cost/(benefit): Long-term incentive plan payout $ 5,723 $ -- $ (286) $ -- $ 5,437 Proposed settlement of a lawsuit -- -- 1,897 1,897 Prepayment penalty and write-off of debt issuance costs related to early extinguishment and refinancing of debt 2,164 -- (134) -- 2,030 Expenses related to debt registration -- -- -- 727 727 Tax adjustments and settlements from prior year returns -- -- (1,020) (600) (1,620) Equity in loss of VITAS prior to the acquistion 4,105 -- -- -- 4,105 Adjustment of transaction-related expenses of the VITAS acquisition -- (821) (131) 1,174 222 ------- ------- ------- ------ -------- Total $11,992 $ (821) $(1,571) $3,198 $ 12,798 ======= ======= ======= ====== ======== 39
SELECTED FINANCIAL DATA Chemed Corporation and Subsidiary Companies (in thousands, except per share and footnote data, ratios, percentages and personnel) 2005 2004 (b) 2003 2002 2001 -------- -------- -------- -------- -------- SUMMARY OF OPERATIONS Continuing operations (a) Service revenues and sales ....................... $926,477 $735,341 $260,776 $253,687 $269,353 Gross profit (excluding depreciation) ............ 274,636 228,263 113,958 112,741 117,800 Depreciation ..................................... 16,179 14,542 9,519 10,424 10,750 Amortization ..................................... 5,322 3,779 302 152 3,737 Income/(loss) from operations .................... 79,384 58,106 8,774 17,141 (10,609) Income/(loss) from continuing operations (c) ..... 37,705 19,186 11,188 11,107 (10,052) Net income/(loss) (c) ............................ 35,817 27,512 (3,435) (2,545) (12,185) Earnings/(loss) per share Income/(loss) from continuing operations ......... $ 1.48 $ 0.80 $ 0.56 $ 0.57 $ (0.52) Net income/(loss) ................................ 1.40 1.14 (0.17) (0.13) (0.63) Average number of shares outstanding ............. 25,552 24,120 19,848 19,716 19,428 Diluted earnings/ (loss) per share Income/ (loss) from continuing operations ........ $ 1.43 $ 0.78 $ 0.56 $ 0.56 $ (0.52) Net income/ (loss) ............................... 1.36 1.12 (0.17) (0.13) (0.63) Average number of shares outstanding ............. 26,299 24,636 19,908 19,770 19,428 Cash dividends per share ............................ $ 0.24 $ 0.24 $ 0.24 $ 0.23 $ 0.22 Net income/(loss) excluding goodwill amortization (d) Net income/(loss) ................................ $ 35,817 $ 27,512 $ (3,435) $ (2,545) $ (7,564) Earnings/(loss) per share ........................ 1.40 1.14 (0.17) (0.13) (0.39) Diluted earnings/(loss) per share ................ 1.36 1.12 (0.17) (0.13) (0.39) FINANCIAL POSITION--YEAR-END Cash and cash equivalents ........................... $ 57,133 $ 71,448 $ 50,688 $ 37,570 $ 8,348 Working capital ..................................... 35,355 28,439 32,778 20,075 9,732 Current ratio ....................................... 1.21 1.17 1.48 1.28 1.11 Properties and equipment, at cost less accumulated depreciation ......................... $ 65,449 $ 55,796 $ 31,440 $ 30,912 $ 36,728 Total assets ........................................ 835,085 825,566 328,458 337,822 399,560 Long-term debt ...................................... 234,058 279,510 25,931 25,348 60,439 Convertible junior subordinated debentures .......... -- -- 14,126 14,186 14,239 Stockholders' equity ................................ 384,175 332,092 192,693 198,422 204,160 OTHER STATISTICS--CONTINUING OPERATIONS Capital expenditures ................................ $ 25,956 $ 18,290 $ 10,381 $ 8,440 $ 9,761 Number of employees ................................. 10,881 9,822 2,894 2,736 3,035 - ---------- (a) Continuing operations exclude Service America, discontinued in 2004, Patient Care, discontinued in 2002, and Cadre Computer Resources, discontinued in 2001. (b) The financial results of VITAS are included in the consolidated results of the Company beginning on February 24, 2004, the date the Company acquired the remaining 63% of VITAS it did not own, bringing its ownership in VITAS to 100%. (c) The following amounts are included in income from continuing operations during the respective year (in thousands): 2005 2004 2003 2002 2001 ------ ------ ------ ---- ------ Aftertax cost/(benefit): Long-term incentive plan payout 3,434 5,437 -- -- -- Legal expenses incurred in connection with the Office of Inspector General investigation 397 -- -- -- -- Adjustment to casualty insurance related to prior periods experience (1,014) -- -- -- -- Prepayment penalty and write-off of debt issuance costs related to early extinguishment and refinancing of debt 2,523 2,030 -- -- 1,701 Tax adjustments and settlements from prior year returns (1,961) (1,620) -- -- -- Adjustment of transaction-related expenses of the VITAS acquisition (961) 222 -- -- -- Cost of accelerating vesting of stock options 137 -- -- -- -- Proposed settlement of lawsuit 10,757 1,897 -- -- -- Equity in (earnings) loss of VITAS -- 4,105 (922) -- -- Expenses related to debt registration -- 727 -- -- -- Severance and restructuring costs -- -- 2,358 -- 15,271 Capital gains on sale of investments -- -- (3,351) (775) (703) Amortization of goodwill (d) -- -- -- -- 3,081 ------ ------ ------ ---- ------ Total 13,312 12,798 (1,915) (775) 19,350 ====== ====== ====== ==== ====== (d) In accordance with FASB Statement No. 142, amortization of goodwill ceased December 31, 2001. Aftertax amortization of goodwill for all operations for 2001, including discontinued operations, was $4,621,000. 40
Chemed Corporation and Subsidiary Companies MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXECUTIVE SUMMARY We operate through our two wholly owned subsidiaries, VITAS Healthcare Corporation ("VITAS") and Roto-Rooter Group, Inc. ("Roto-Rooter"). VITAS focuses on hospice care that helps make terminally ill patients' final days as comfortable as possible. Through its team of doctors, nurses, home health aides, social workers, clergy and volunteers, VITAS provides direct medical services to patients, as well as spiritual and emotional counseling to both patients and their families. Roto-Rooter is focused on providing plumbing and drain cleaning services to both residential and commercial customers. Through its network of company-owned branches, independent contractors and franchisees, Roto-Rooter offers plumbing and drain cleaning service to over 90% of the U.S. population. The following is a summary of the key operating results for the years ended December 31, 2005, 2004 and 2003 (in thousands except per share amounts): 2005 2004 2003 -------- -------- -------- Consolidated service revenues and sales $926,477 $735,341 $260,776 Consolidated income from continuing operations 37,705 19,186 11,188 Diluted EPS from continuing operations 1.43 0.78 0.56 2005 VERSUS 2004 The increase in consolidated service revenues and sales from 2004 to 2005 was driven by a 37% increase at VITAS and a 7% increase at Roto-Rooter. The increase at VITAS was the result of an increase in average daily census ("ADC") of 15%, the annual Medicare price increase of approximately 3% and a full year of revenue in 2005 versus a partial year in 2004 due to our acquisition of VITAS in February 2004. The increase at Roto-Rooter was driven by an increase in plumbing revenue of 15% and an increase in sewer and drain cleaning revenue of 6%. Consolidated income from continuing operations and diluted EPS from continuing operations increased in 2005 as a result of the higher service revenues and sales, which allowed us to further leverage our current cost structure. The increase was partially offset by a $17.4 million pretax charge ($10.8 million aftertax) at VITAS for the anticipated settlement of a class action lawsuit. Consolidated income from continuing operations as a percent of service revenues and sales was 4.1% for 2005 versus 2.6% for 2004. 2004 VERSUS 2003 The increase in consolidated service revenues and sales from 2003 to 2004 was driven by the February 24, 2004 acquisition of VITAS and a 6% increase at Roto-Rooter. The increase at Roto-Rooter was driven primarily by a 6% increase in plumbing revenue and a 5% increase in sewer and drain cleaning revenue. Consolidated income from continuing operations and diluted EPS from continuing operations increased as a result of the VITAS acquisition. LIQUIDITY AND CAPITAL RESOURCES Significant factors affecting our cash flows during 2005 and financial position at December 31, 2005 include the following: - Our continuing operations generated cash of $81.6 million; - We spent net cash of $6.2 million on business combinations; - We borrowed $85 million in long-term debt; - We repaid $141.6 million to reduce long-term debt; and - We spent $26.0 million on capital expenditures. The ratio of total debt to total capital was 38.0% at December 31, 2005 compared with 46.8% at December 31, 2004. Our current ratio was 1.2 at both December 31, 2005 and 2004. Our current credit agreements restrict annual payments for dividends, stock repurchases, acquisitions and capital expenditures. Should we generate excess cash flow during a year, as defined in the credit agreements, an additional principal payment may be required. No additional payment is required for the year ended December 31, 2005. We had $147 million of unused eligible lines of credit at December 31, 2005. We believe our cash flow from operating activities and our unused eligible lines of credit are sufficient to fund our business in the near term. 41
Chemed Corporation and Subsidiary Companies CASH FLOW Our cash flows for 2005, 2004 and 2003 are summarized as follows (in millions): For the Years Ended December 31, -------------------------------- 2005 2004 2003 ------- ------- ------ Net cash provided by operating activities $ 80.0 $ 92.9 $ 23.8 Capital expenditures (26.0) (18.3) (10.4) ------- ------- ------ Operating cash excess after capital expenditures 54.0 74.6 13.4 Repayment of long-term debt (141.6) (96.9) -- Proceeds from issuance of long-term debt, net of costs 83.2 280.6 -- Issuance of capital stock, net of costs 12.3 98.8 3.3 Net proceeds/(uses) from sale of discontinued operations (9.4) (0.8) 1.1 Dividends paid (6.2) (5.7) (4.8) Business combinations (6.2) (344.7) (3.9) Return/(payment) of VITAS merger deposit -- 10.0 (10.0) Proceeds from redemption of available-for-sale securities -- -- 27.3 Investment in VITAS equity interest -- -- (18.0) Other--net (0.4) 4.9 4.7 ------- ------- ------ (Decrease)/increase in cash and cash equivalents $ (14.3) $ 20.8 $ 13.1 ======= ======= ====== For 2005, the operating cash excess after capital expenditures was $54.0 million as compared with $74.6 million in 2004 and $13.4 million in 2003. This excess was used mainly to reduce long-term debt in 2005 and 2004. In 2003, this excess, along with the proceeds from the redemption of VITAS preferred stock, was used to purchase 37% of VITAS common stock, to place a deposit of $10.0 million to secure our merger offer for VITAS' remaining common stock, to pay cash dividends and to increase our available cash and cash equivalents. COMMITMENTS AND CONTINGENCIES In connection with the sale of DuBois Chemicals, Inc. ("DuBois") in 1991, we provided allowances and accruals relating to several long-term costs, including income tax matters, lease commitments and environmental costs. Also, in conjunction with the sales of The Omnia Group ("Omnia") and National Sanitary Supply Company in 1997, the sale of Cadre Computer Resources, Inc. ("Cadre Computer") in 2001 and the sale of Service America Network Inc. ("Service America") in 2005, we provided long-term allowances and accruals relating to costs of severance arrangements, lease commitments and income tax matters. Additionally, we retained liability for Service America's casualty insurance claims that were incurred prior to the disposal date. In the aggregate, we believe these allowances and accruals are adequate as of December 31, 2005. Based on reviews of our environmental-related liabilities under the DuBois sale agreement, we have estimated our remaining liability to be $3.0 million. As of December 31, 2005, we are contingently liable for additional cleanup and related costs up to a maximum of $16.0 million, for which no provision has been recorded in accordance with the applicable accounting guidance. In connection with the sale of Patient Care in 2002, $5.0 million of the cash purchase price was placed in escrow pending collection of third-party payer receivables on Patient Care's balance sheet at the sale date. To date, $4.2 million has been returned and the remainder is being withheld pending the settlement of certain third-party payer claims. Based on Patient Care's collection history, we believe that the significant majority of the disputed amounts will be resolved in Patient Care's favor and most of the withheld escrow will be returned to us. We have a long-term note receivable from Patient Care of $12.5 million as of December 31, 2005. Patient Care is current with all payments due related to the long-term note receivable. We also have current accounts receivable from Patient Care for the post-closing balance sheet valuation ($1.3 million) and for expenses paid by us after closing on Patient Care's behalf ($1.9 million). We are in litigation with Patient Care over various issues, including the collection of these amounts. We believe these balances represent valid claims, are fairly stated and are fully collectible; nonetheless, an unfavorable determination by the courts could result in the write-off of all or a portion of these balances. Our various loan agreements and guarantees of indebtedness as of December 31, 2005, contain certain restrictive covenants. In addition, certain agreements contain cross-default provisions. We are in compliance with all of the covenants at December 31, 2005 and anticipate continued compliance throughout 2006. We are party to a class action lawsuit filed in the Third Judicial Circuit Court of Madison County, Illinois in June of 2000 by Robert Harris, alleging certain Roto-Rooter plumbing was performed by unlicensed employees. We contest these allegations and believe them without merit. Plaintiff moved for certification of a class of customers in 32 states who 42
Chemed Corporation and Subsidiary Companies allegedly paid for plumbing work performed by unlicensed employees. Plaintiff also moved for partial summary judgment on grounds the licensed apprentice plumber who installed his faucet did not work under the direct personal supervision of a licensed master plumber. On June 19, 2002, the trial judge certified an Illinois-only plaintiffs class and granted summary judgment for the named party Plaintiff on the issue of liability, finding violation of the Illinois Plumbing License Act and the Illinois Consumer Fraud Act through Roto-Rooter's representation of the licensed apprentice as a plumber. The court has not ruled on certification of a class in the remaining 31 states. In December 2004, we reached a resolution of this matter with the Plaintiff. This proposed settlement has been preliminarily approved by the court. We expect the parties to request final approval during 2006. We accrued $3.1 million in 2004 as the anticipated cost of settling this litigation. Like other large California employers, our VITAS subsidiary faces allegations of purported class-wide wage and hour violations. It is party to a class action lawsuit filed in the Superior Court of California, Los Angeles County, in April of 2004 by Ann Marie Costa, Ana Jimenez, Mariea Ruteaya and Gracetta Wilson. This case alleges failure to pay overtime wages for hours worked "off the clock" on administrative tasks, including voicemail retrieval, time entry, travel to and from work, and pager response. This case also alleges VITAS failed to provide meal and break periods to a purported class of California nurses, home health aides and licensed clinical social workers. The case also seeks payment of penalties, interest, and Plaintiffs' attorney fees. VITAS contested these allegations. Plaintiff moved for class certification, and VITAS opposed this motion. We have reached an agreement, which is subject to court approval, with the Plaintiff class in order to avoid the uncertainty of litigation and the diversion of resources and personnel resulting from the litigation. In connection with our acquisition of VITAS in February 2004, we recorded a liability of $2.3 million on VITAS' opening balance sheet for this case. At that time, this represented our best estimate of our exposure in the matter. As a result of the tentative resolution, we recorded a pretax charge of $17.4 million ($10.8 million aftertax), representing the portion of this settlement not accounted for on Vitas' opening balance sheet. These amounts are inclusive of Plaintiffs' class attorneys' fees and the costs of settlement administration. On April 7, 2005, we announced the Office of Inspector General ("OIG") for the Department of Health and Human Services served VITAS with civil subpoenas relating to VITAS' alleged failure to appropriately bill Medicare and Medicaid for hospice services. As part of this investigation, the OIG selected medical records for 320 past and current patients from VITAS' three largest programs for review. It also sought policies and procedures dating back to 1998 covering admissions, certifications, recertifications and discharges. During the third quarter of 2005, the OIG requested additional information from us. The U.S. Attorney General has since provided us with a copy of a qui tam complaint filed under seal in U.S. District Court for the Southern District of Florida. The complaint and all filings in the qui tam action remain under seal. We are conferring with the U.S. Attorney regarding our defenses to the complaint allegations. The U.S. Attorney has not decided whether to intervene in the qui tam action. We have incurred pretax expense related to complying with OIG requests of $637,000 for the year ended December 31, 2005. The government continues to investigate the complaint's allegations. We are unable to predict the outcome of this matter or the impact, if any, that the investigation may have on the business, results of operations, liquidity or capital resources. Regardless of outcome, responding to the subpoenas can adversely affect us through defense costs, diversion of our time and related publicity. CONTRACTUAL OBLIGATIONS The table below summarizes our debt and contractual obligations as of December 31, 2005 (in thousands): Less Than After Total 1 Year 1 - 3 Years 4 - 5 Years 5 Years -------- --------- ----------- ----------- -------- Long-term debt obligations, excluding interest (a) $235,103 $ 1,045 $ 2,067 $ 1,878 $230,113 Operating lease obligations 64,427 17,360 23,940 13,680 9,447 Severance obligations 3,094 2,128 484 482 -- Purchase obligations (b) 43,626 43,626 -- -- -- Other current obligations (c) 19,952 19,952 -- -- -- Other long-term obligations (d) 24,687 -- 1,364 1,365 21,958 -------- ------- ------- ------- -------- Total contractual cash obligations $390,889 $84,111 $27,855 $17,405 $261,518 ======== ======= ======= ======= ======== - ---------- (a) Estimated interest payments on long-term debt amount to $19.6 million in less than 1 year, $38.9 million in years 1-3, $36.6 million in years 4-5 and $6.6 million after 5 years. (b) Purchase obligations primarily consist of accounts payable at December 31, 2005. (c) Other current obligations consist of accrued salaries and wages at December 31, 2005. (d) Other long-term obligations comprise largely pension and excess benefit obligations. 43
Chemed Corporation and Subsidiary Companies RESULTS OF OPERATIONS 2005 VERSUS 2004 - CONSOLIDATED RESULTS Set forth below are the year-to-year changes in the components of the statement of operations relating to continuing operations for 2005 versus 2004 (in thousands, except percentages): Increase/(Decrease) ------------------- Amount Percent -------- ------- Service revenues and sales VITAS $170,410 37% Roto-Rooter 20,726 7 -------- Total 191,136 26 Cost of services provided and goods sold 144,763 29 Selling, general and administrative expenses 13,385 10 Depreciation 1,637 11 Amortization 1,543 41 Other expenses 8,530 63 -------- Income from operations 21,278 37 Interest expense 106 1 Loss on extinguishment of debt 641 19 Other income--net (335) (10) -------- Income before income taxes 20,196 54 Income taxes 5,782 42 Equity in loss of affiliate 4,105 100 -------- Income from continuing operations $ 18,519 97% ======== Our service revenues and sales for the year ended December 31, 2005 increased $191 million, or 26%, versus revenues for the year ended December 31, 2004. The VITAS segment, acquired in February 2004, accounted for $170 million of this increase and Roto-Rooter accounted for the remaining $21 million of the increase. The increase in VITAS' revenues for 2005 versus 2004 is attributable to the following (dollars in thousands): Amount Percent -------- ------- Routine Homecare $119,586 37.7% Continuous Care 27,748 36.6 General Inpatient 23,076 35.3 -------- Total revenues $170,410 37.2% ======== The revenue increases for VITAS resulted from the annual price increase in the Medicare reimbursement rate of approximately 3% and the impact of a full year of revenue in 2005 versus a partial year in 2004 due to our acquisition of VITAS in February 2004. In addition, the Average Daily Census ("ADC") for routine homecare, continuous care and general inpatient increased 16%, 12% and 11% respectively from 2004. ADC is a key measure we use to monitor volume growth in our hospice programs. Changes in total program admissions and average length of stay for our patients are the main drivers of changes in ADC. A comparison of VITAS' 2005 revenues to full year pro-forma revenues for 2004 indicates increases of 20%, 16% and 15%, respectively, for routine homecare, continuous care and general inpatient revenues. The increase in Roto-Rooter's service revenues and sales for 2005 versus 2004 is attributable to the following (in thousands): Amount Percent ------- ------- Plumbing $10,983 9.8% Sewer and drain cleaning 5,051 4.5 Other 4,692 8.2 ------- Total revenues $20,726 7.5% ======= 44
Chemed Corporation and Subsidiary Companies Plumbing revenues for 2005 increased from 2004 due to a 5% increase in the number of jobs performed and a 5% increase in the average price per job. Sewer and drain cleaning revenues for 2005 increased from 2004 due to a 1% decrease in the number of jobs offset by a 6% increase in the average price per job. The increase in the price per job for both plumbing and sewer and drain cleaning was driven by a shift in job mix from residential to commercial. Generally, commercial jobs produce more revenue on a per job basis. The increase in other revenues is attributable primarily to increases in independent contractor operations. The consolidated gross margin was 29.6% in 2005 versus 31.0% in 2004. The slight decrease is due to the acquisition of VITAS in February 2004. On a segment basis, VITAS' gross margin was 22% in 2005 and 2004. Roto-Rooter's gross margin was 46% in 2005 and 2004. Selling, general and administrative expenses ("SG&A") for 2005 increased $13.4 million (10%) versus 2004 mainly as a result of a full year of VITAS expense and the impact of higher revenues on variable selling costs such as commissions. The change in SG&A by segment is summarized below (in thousands): Increase in VITAS expense $11,860 Increase in Roto-Rooter expense 2,410 Decrease in Corporate expense (885) ------- Total increase $13,385 ======= Depreciation for 2005 increased $1.6 million, or 11%, versus 2004 primarily as a result of the VITAS acquisition. Similarly, most of the $1.5 million increase in amortization is attributable to the amortization of VITAS' intangible assets, including the referral networks and the covenant not to compete. Income from operations for 2005 increased $21.3 million (37%) versus 2004 as summarized below (in thousands): Increase in gross margin from VITAS $ 35,237 Increase in gross margin from Roto-Rooter 11,136 Increase in SG&A expenses, depreciation and amortization (16,565) Anticipated cost in 2005 of settling VITAS class action litigation (17,350) Favorable variance in compensation expense from the LTIP in 2005 versus 2004 3,306 Anticipated cost in 2004 of settling Roto-Rooter litigation 3,135 Favorable variance in VITAS transaction related costs and adjustments 1,403 Professional fees in 2004 incurred to register Floating Rate Notes 1,191 Cost of accelerating the vesting of outstanding stock options in 2005 (215) -------- Total increase $ 21,278 ======== Our effective income tax rate was 34.2% in 2005 versus 37.2% in 2004. The decrease in our effective tax rate relates to certain state income tax planning strategies implemented in 2005 and the impact of a full year of VITAS activity. Income from continuing operations for 2005 increased $18.5 million (97%) versus 2004 as summarized below (in thousands): Increase in income from operations $21,278 Increase in income tax expense (5,782) Equity in loss of VITAS prior to the February 2004 acquisition 4,105 Other (1,082) ------- Total increase $18,519 ======= Income/(loss) from discontinued operations for 2005, 2004 and 2003 follows (in thousands): For the Years Ended December 31, --------------------------- 2005 2004 2003 ------- ------ -------- Service America $(1,813) $8,559 $(14,687) Adjustment to accruals of operations discontinued in prior years (75) (233) 64 ------- ------ -------- Income/(loss) from discontinued operations $(1,888) $8,326 $(14,623) ======= ====== ======== 45
Chemed Corporation and Subsidiary Companies The disposal of Service America was completed in May 2005. The loss on disposal of Service America in 2005 arises from the finalization of asset and liability values and related tax benefits resulting from the consummation of the sale transaction. For 2004, the gain for Service America includes an estimated tax benefit on the disposal of approximately $14.2 million, primarily due to the recognition of non-deductible goodwill impairment losses in prior years. For 2003, the loss from Service America includes aftertax impairment charges of $14.4 million. Of this amount, $10.0 million was for goodwill impairment and the remainder was for impairment of computer software and identifiable intangible assets. The adjustments to accruals related to operations discontinued in prior years primarily include favorable adjustments to accruals for note receivable losses on the sale of Cadre Computer (discontinued in 2001) and unfavorable adjustments to accruals related to the sale of DuBois in 1991. Cadre Computer has been operating profitably since 2001 and is current on all amounts due the Company. As a result, we reduced our allowance to $323,000 at December 31, 2003 and to nil at December 31, 2004. Adjustments to the DuBois accruals relate to environmental liabilities we retained upon the sale of DuBois in 1991. We believe amounts accrued are reasonable under the circumstances, but due to the nature of the liabilities, we could be required to increase the accrual in future years to cover additional charges. 2005 VERSUS 2004 - SEGMENT RESULTS During 2005, VITAS net income increased $4.4 million (15%) from $29.1 million during 2004 to $33.5 million during 2005, as summarized below (in thousands): Increase in gross margin in 2005 $ 35,237 Increase in SG&A, depreciation and amortization (14,731) Anticipated cost in 2005 of settling VITAS litigation (17,350) Increase in income tax expense (364) Other 1,656 -------- Total increase $ 4,448 ======== Roto-Rooter's net income increased $8.2 million (43%) from $18.8 million during 2004 to $27.0 million during 2005 as summarized below (in thousands): Increase in gross margin in 2005 $11,136 Increase in SG&A, depreciation and amortization (2,069) Increase in income tax expense (5,024) Anticipated cost in 2004 of settling Roto-Rooter litigation 3,135 Other 987 ------- Total increase $ 8,165 ======= Net Corporate aftertax expenses decreased $1.8 million (7%) from $24.6 million in 2004 to $22.9 million in 2005 as summarized below (in thousands): Favorable variance in LTIP costs in 2005 versus 2004 $ 2,681 Unfavorable variance in intercompany interest expense in 2005 versus 2004 (2,013) Favorable variance in Corporate overhead expenses in 2005 versus 2004 1,176 Professional fees in 2004 incurred to register Floating Rate Notes 727 Unfavorable variance on loss from extinguishment of debt in 2005 versus 2004 (493) Favorable variance in VITAS transaction related costs and adjustments 175 Cost of accelerating the vesting of outstanding stock options in 2005 (137) Other (315) ------- Total decrease $ 1,801 ======= 46
Chemed Corporation and Subsidiary Companies 2004 VERSUS 2003 - CONSOLIDATED RESULTS Set forth below are the year-to-year changes in the components of the statement of operations relating to continuing operations for 2004 versus 2003 (in thousands, except percentages): Increase/(Decrease) ------------------- Amount Percent -------- -------- Service revenues and sales VITAS $458,730 n.a.% Roto-Rooter 15,835 6 -------- Total 474,565 182 Cost of services provided and goods sold 360,260 245 Selling, general and administrative expenses 42,922 45 Depreciation 5,023 53 Amortization 3,477 1,151 Other expenses 13,551 n.a. -------- Income from operations 49,332 562 Interest expense 17,981 566 Loss on extinguishment of debt 3,330 n.a. Other income--net (7,380) (68) -------- Income before income taxes 20,641 126 Income taxes 7,616 123 Equity in loss of affiliate (5,027) n.a. -------- Income from continuing operations $ 7,998 71% ======== Our service revenues and sales for the year ended December 31, 2004 increased $474.6 million, or 182%, versus revenues for the year ended December 31, 2003. The VITAS segment, acquired in February 2004, accounted for $458.7 million of this increase and Roto-Rooter accounted for the remaining $15.8 million of the increase. VITAS' revenues for 2004 comprised the following (in thousands): Routine homecare $316,374 Continuous care 78,669 General inpatient 63,051 Other 636 -------- Total revenues $458,730 ======== The increase in Roto-Rooter's service revenues and sales for 2004 versus 2003 is attributable to the following (in thousands): Plumbing $ 6,052 Sewer and drain cleaning 5,740 Other 4,043 ------- Total increase $15,835 ======= Plumbing revenues for 2004 increased $6.0 million, or 6.0%, versus revenues for 2003 due to a 4.4% increase in the number of jobs performed and a 1.6% increase in the average price per job. Sewer and drain cleaning revenues increased $5.7 million or 5.4%, versus revenues for 2003 due to a .5% decline in the number of jobs which was more than offset by a 5.9% increase in the average price per job. On a same-store basis, the number of plumbing jobs increased 4.9% and the number of sewer and drain cleaning jobs declined .7%. The increase in other revenues is attributable primarily to increases in independent contractor operations and other services. The consolidated gross margin was 31.0% in 2004 as compared with 43.7% in 2003 largely due to the acquisition of VITAS in 2004. On a segment basis, VITAS' gross margin was 22.2% and Roto-Rooter's gross margin increased from 47
Chemed Corporation and Subsidiary Companies 43.7% in 2003 to 45.7% in 2004. This increase is largely due to lower training wages as a percent of revenues in 2004 versus 2003 and lower health insurance costs as a percent of revenues in 2004. Selling, general and administrative expenses ("SG&A") for 2004 increased $42.9 million versus 2003 as summarized below (in thousands): VITAS SG&A for 2004 $42,946 Corporate severance in 2003 (3,627) Professional fees at the Corporate Office related to complying with the internal controls provisions of the Sarbanes-Oxley Act 2,301 Higher Roto-Rooter advertising costs in 2004 2,226 Other (924) ------- Total increase $42,922 ======= Depreciation for 2004 increased $5.0 million, or 53%, versus 2003 primarily as a result of the VITAS acquisition. Similarly, most of the increase in amortization is attributable to the amortization of VITAS' intangible assets, including the referral network and the covenant not to compete. Income from operations for 2004 increased $49.3 million versus 2003 as summarized below (in thousands): VITAS income from operations for 2004 $48,242 Higher gross profit of the Roto-Rooter segment in 2004 12,377 Long-term incentive compensation in 2004 (8,783) Corporate Office severance in 2003 3,627 Anticipated cost in 2004 of settling Roto-Rooter litigation (3,135) Professional fees at the Corporate Office related to complying with the internal controls provisions of the Sarbanes-Oxley Act (2,301) Other (695) ------- Total increase $49,332 ======= Our effective income tax rate was 37.2% in 2004 versus 37.6% in 2003. Favorable income tax adjustments in 2004 related to prior-period tax issues reduced our effective rate by 4.7 percentage points. Our effective state and local income tax rate for 2004 was 6.1% as compared with 4.4% for 2003. This increase is due largely to the higher effective state and local tax rate of VITAS. Income from continuing operations for 2004 increased $8.0 million versus 2003 as summarized below (in thousands): Net income of VITAS in 2004 $ 29,139 Higher net income of Roto-Rooter 5,619 Higher interest costs in 2004 related to debt incurred to fund the acquisition of VITAS (11,314) Long-term incentive compensation for the Corporate Office in 2004 (4,455) Equity in the loss of VITAS prior to the merger in 2004 (4,105) Capital gains on the sales and redemption of available-for-sale investments in 2003 (3,351) Income from VITAS' preferred dividend and equity earnings in 2003 (2,507) Corporate severance in 2003 2,358 Loss on extinguishment of debt in 2004 (2,030) Professional fees at the Corporate Office related to complying with the internal controls provisions of the Sarbanes-Oxley Act (1,461) Favorable income tax adjustments in 2004 for the Corporate Office related to prior years' issues 990 Professional fees related to registering debt in 2004 (727) Other (158) -------- Total increase $ 7,998 ======== 48
Chemed Corporation and Subsidiary Companies Income/(loss) from discontinued operations for 2004 and 2003 follows (in thousands): For the Years Ended December 31, ------------------- 2004 2003 ------- --------- Service America 8,559 (14,687) Adjustment to accruals of operations discontinued in prior years (233) 64 ------ -------- Income/(loss) from discontinued operations $8,326 $(14,623) ====== ======== For 2004, the gain for Service America includes an estimated tax benefit on the disposal of approximately $14.2 million, primarily due to the recognition of non-deductible goodwill impairment losses in prior years. For 2003, the loss from Service America includes aftertax impairment charges of $14.4 million. Of this amount, $10.0 million was for goodwill impairment and the remainder was for impairment of computer software and identifiable intangible assets. The adjustments to accruals related to operations discontinued in prior years primarily include favorable adjustments to accruals for note receivable losses on the sale of Cadre Computer (discontinued in 2001) and unfavorable adjustments to accruals related to the sale of DuBois in 1991. Cadre Computer has been operating profitably since 2001 and is current on all amounts due the Company. As a result, we reduced our allowances for losses on these notes receivable from $422,000 at December 31, 2002 to $323,000 at December 31, 2003 and to nil at December 31, 2004. Adjustments to the DuBois accruals relate to environmental liabilities we retained upon the sale of DuBois in 1991. We believe amounts accrued are reasonable under the circumstances, but due to the nature of the liabilities, we could be required to increase the accrual in future years to cover additional charges. 2004 VERSUS 2003 - SEGMENT RESULTS During 2004, VITAS generated net income of $29.1 million. These earnings included aftertax transaction expenses totaling $1.0 million related to our acquisition of VITAS in 2004. VITAS' average daily census ("ADC") during 2004 increased from 7,979 during the fourth quarter of 2003 to 9,134 during the fourth quarter of 2004. During that same period, the quarterly average length of stay increased from 59.0 days to 64.1 days, and the median length of stay was 12.0 days during the fourth quarters of both 2004 and 2003. Roto-Rooter's net income increased $5.6 million (43%) from $13.2 million during 2003 to $18.8 million during 2004 as summarized below (in thousands): Aftertax impact of higher gross profit in 2004 $ 7,649 Anticipated cost in 2004 of settling litigation (1,897) Roto-Rooter's share of long-term compensation in 2004 (982) Favorable income tax adjustments in 2004 related to prior years' issues 630 Other 219 ------- Total increase $ 5,619 ======= Net Corporate aftertax expenses increased $21.7 million from $2.9 million in 2003 to $24.6 million in 2004 as summarized below (in thousands): Higher interest costs in 2004 related to debt incurred to fund the acquisition of VITAS $11,314 Corporate Office share of long-term compensation in 2004 4,455 Capital gains on the sales and redemption of available-for-sale investments in 2003 3,351 Corporate severance in 2003 (2,358) Loss on extinguishment of debt in 2004 2,030 Income from VITAS preferred dividend in 2003 1,585 Professional fees at the Corporate Office related to complying with the internal controls provisions of the Sarbanes-Oxley Act 1,461 Favorable income tax adjustments in 2004 for the Corporate Office related to prior years' issues (990) Professional fees related to registering debt in 2004 727 Other 158 ------- Total increase $21,733 ======= 49
Chemed Corporation and Subsidiary Companies CRITICAL ACCOUNTING POLICIES REVENUE RECOGNITION For both the Roto-Rooter and VITAS segments, service revenues and sales are recognized when the earnings process has been completed. Generally, this occurs when services are provided or products are delivered. VITAS recognizes revenue at the estimated net realizable amount due from third-party payers, which are primarily Medicare and Medicaid. Payers may deny payment for services in whole or in part on the basis that such services are not eligible for coverage and do not qualify for reimbursement. We estimate denials each period and make adequate provision in the financial statements. VITAS is subject to certain limitations on Medicare payments for services. Specifically, if the number of inpatient care days any hospice program provides to Medicare beneficiaries exceeds 20% of the total days of hospice care such program provides to all patients for an annual period beginning September 28, the days in excess of the 20% figure may be reimbursed only at the routine homecare rate. None of VITAS' hospice programs exceeded the payment limits on inpatient services in 2005 or 2004. VITAS is also subject to a Medicare annual per-beneficiary cap ("Medicare cap"). Compliance with the Medicare cap is measured by comparing the total Medicare payments received under a Medicare provider number with respect to services provided to all Medicare hospice care beneficiaries in the program or programs covered by that Medicare provider number between November 1 of each year and October 31 of the following year with the product of the per-beneficiary cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice program or programs during the relevant period. We actively monitor each of our hospice programs, by provider number, as to their specific admissions, discharge rate and average length of stay data in an attempt to determine whether they are likely to exceed the Medicare cap. Should we determine that a provider number is likely to exceed the Medicare cap based on projected trends, we attempt to institute corrective action to influence the patient mix or to increase patient admissions. However, should we project our corrective action will not prevent that program from exceeding its Medicare cap, we estimate the amount we will be required to repay at the end of the measurement year and accrue that amount, which is proportional to the number of months elapsed in the Medicare cap year, as a reduction of patient revenue. INSURANCE ACCRUALS For the Roto-Rooter segment and Chemed's Corporate Office, we self-insure for all casualty insurance claims (workers' compensation, auto liability and general liability). As a result, we closely monitor and frequently evaluate our historical claims experience to estimate the appropriate level of accrual for self-insured claims. Our third-party administrator ("TPA") processes and reviews claims on a monthly basis. Currently, our exposure on any single claim is capped at $500,000. For most of the prior years, the caps for general liability and workers' compensation were between $250,000 and $500,000 per claim. In developing our estimates, we accumulate historical claims data for the previous 10 years to calculate loss development factors ("LDF") by insurance coverage type. LDFs are applied to known claims to estimate the ultimate potential liability for known and unknown claims for each open policy year. LDFs are updated annually. Because this methodology relies heavily on historical claims data, the key risk is whether the historical claims are an accurate predictor of future claims exposure. The risk also exists that certain claims have been incurred and not reported on a timely basis. To mitigate these risks, in conjunction with our TPA, we closely monitor claims to ensure timely accumulation of data and compare claims trends with the industry experience of our TPA. For the VITAS segment, we self insure for workers' compensation exposures. Currently, VITAS' exposure on any single claim is capped at $500,000. For most of the prior years, the caps for workers' compensation were between $250,000 and $500,000 per claim. For VITAS' self-insurance accruals for workers' compensation, we obtained an actuarial valuation of the liability as of the date of acquisition and as of November 30, 2005 and 2004. The valuation methods used by the actuary are similar to those used internally for our other business units. As an indication of the sensitivity of the accrued liability to reported claims, our analysis indicates that a 1% across-the-board increase or decrease in the amount of projected losses for all of our continuing operations would increase or decrease the accrued insurance liability at December 31, 2005, by $1,157,000 or 3%. INCOME TAXES Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss carry-forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amount of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in laws and rates on the date of enactment. We are subject to income taxes in the U.S. Federal and most state jurisdictions. Significant judgment is required to determine our provision for income taxes. We are periodically audited by various taxing authorities. We establish liabilities for possible assessments by taxing authorities resulting from exposures including, but not limited to, the deductibility of 50
Chemed Corporation and Subsidiary Companies certain expenses and the tax treatment of acquisitions and divestitures. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe our tax reserves reflect the probable outcome of known contingencies. On June 30, 2005, significant changes to the tax system of the State of Ohio were enacted. The impact was required to be accounted for in all annual and interim periods ending on or after June 30, 2005. Changes in the Ohio tax legislation include the phasing out of the Ohio income tax and the Ohio personal property tax. Additionally, a new Commercial Activity Tax ("CAT"), which is based on gross receipts, was introduced. Since the corporate income tax is being replaced by the CAT, which is not an income tax under generally accepted accounting principles, entities with businesses in the State of Ohio must account for the phase-out of the corporate income tax as a change in enacted tax rate as of June 30, 2005. We recorded a valuation allowance on all significant deferred tax amounts in the State of Ohio, mainly net operating loss carry-forwards, because management believed that it was more likely than not that the benefit would expire unutilized. As such, there was no significant impact to us for the year ended December 31, 2005. GOODWILL AND INTANGIBLE ASSETS Identifiable, definite-lived intangible assets arise from purchase business combinations and are amortized using either an accelerated method or the straight-line method over the estimated useful lives of the assets. The selection of an amortization method is based on which method best reflects the economic pattern of usage of the asset. The VITAS trade name is considered to have an indefinite life. Goodwill and the VITAS trade name are tested at least annually for impairment. The valuation of goodwill and the VITAS trade name is dependent upon many factors, some of which are market-driven and beyond our control. The valuation of goodwill and the VITAS trade name indicate that the fair value exceeds the carrying value at December 31, 2005. RECENT ACCOUNTING STATEMENTS FASB NO. 123R In December 2004, the FASB issued FASB Statement No. 123 (revised 2004) "Share-Based Payment" ("FASB123R"), which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees and disallows the use of the intrinsic value method of accounting for stock options, but expresses no preference for a type of valuation model. This statement supersedes APB No. 25, but does not change the accounting guidance for share-based payment transactions with parties other than employees provided in FASB 123 as originally issued. FASB123R is effective as of January 1, 2006. In March 2005, the Board of Directors approved immediate vesting of all unvested stock options to avoid recognizing approximately $951,000 of pretax expense that would have been charged to income under FASB123R beginning on January 1, 2006. The pretax expense from continuing operations of accelerating the vesting of these stock options, which were scheduled to vest in November 2005 and November 2006, was approximately $215,000 and recorded in the first quarter of 2005. We adopted FASB 123R on January 1, 2006 using the modified prospective method. Therefore, historical financial information will not be restated. There was no significant impact on our financial condition, results of operations or cash flow as a result of adoption of FASB 123R. FASB NO. 154 In May 2005, the FASB issued FASB Statement No. 154, "Accounting for Changes and Error Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3" (FASB 154). FASB 154 changes the requirements with regard to the accounting for and reporting of a change in an accounting principle. The provisions of FASB 154 require, unless impracticable, retrospective application to prior periods presented in financial statements for all voluntary changes in an accounting principle and changes required by the adoption of a new accounting pronouncement in the unusual instance that the new pronouncement does not indicate a specific transition method. FASB 154 also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in an accounting estimate, which requires prospective application of the new method. FASB 154 is effective for all changes in an accounting principle made in fiscal years beginning after December 15, 2005. We adopted FASB 154 with our fiscal year beginning January 1, 2006. There was no impact on our financial condition, results of operations or cash flows upon adoption. FASB NO. 155 In February 2006, the FASB issued FASB Statement No. 155, "Accounting for Certain Hybrid Financial Instruments" (FASB 155), which nullifies and amends various accounting guidance relating to accounting for derivative instruments and securitization transactions. In general, these changes will reduce the operational complexity associated with bifurcating embedded derivatives, and increase the number of beneficial interests in securitization transactions. This statement is effective for all financial instruments acquired or issued after the beginning of our first fiscal year that begins after September 15, 2006. Because we do not have any material derivative instruments or securitization transactions, we believe there will be no material impact on our financial condition, results of operations or cash flows upon adoption. 51
UNAUDITED SUPPLEMENTARY DATA (VITAS) To provide background in analyzing the quarterly operations of the VITAS segment, we are providing the following financial and operating data (in thousands, except percentages, days and dollars per day): 2004 2005 ---------------------------------------- ----------------------- First Quarter ----------------------------- January 1 February 24 to to Fourth Fourth Year-to-date February 23 September 30(a) Quarter Quarter December ----------- --------------- -------- -------- ------------ STATEMENT OF OPERATIONS Service revenues and sales $ 72,870 $316,453 $142,277 $168,994 $629,140 -------- -------- -------- -------- -------- Cost of services provided (excluding depreciation) 58,848 247,971 108,830 130,271 491,974 Selling, general and administrative expenses 8,182 29,940 13,006 14,097 54,806 Depreciation 836 3,078 2,634 2,108 7,585 Amortization 4 2,995 354 1,384 4,347 Other expense 24,956(b) -- 1,680 18,150 19,031 -------- -------- -------- -------- -------- Total costs and expenses 92,826 283,984 126,504 166,010 577,743 -------- -------- -------- -------- -------- Income/(loss) from operations (19,956) 32,469 15,773 2,984 51,397 Interest expense (919) (90) (38) (49) (153) Loss on extinguishment of debt (4,497)(b) -- -- -- -- Other income--net 41 589 466 834 2,737 -------- -------- -------- -------- -------- Income/(loss) before income taxes (25,331) 32,968 16,201 3,769 53,981 Income taxes 6,996 (13,489) (6,541) (1,264) (20,394) -------- -------- -------- -------- -------- Net income/(loss) $(18,335) $ 19,479 $ 9,660 $ 2,505 $ 33,587 ======== ======== ======== ======== ======== EBITDA (c) Net income/(loss) $(18,335) $ 19,479 $ 9,660 $ 2,505 $ 33,587 Add/(deduct) Interest expense 919 90 38 49 153 Income taxes (6,996) 13,489 6,541 1,264 20,394 Depreciation 836 3,078 2,634 2,108 7,585 Amortization 4 2,995 354 1,384 4,347 -------- -------- -------- -------- -------- EBITDA $(23,572) $ 39,131 $ 19,227 $ 7,310 $ 66,066 ======== ======== ======== ======== ======== - ---------- (a) We acquired VITAS on February 24, 2004 and recorded estimated purchase accounting adjustments to the value of VITAS' assets as of that date. (b) Costs related to the sale of VITAS totaled $29,453,000 pretax ($20,930,000 aftertax) for January 1 through February 23, 2004. (c) EBITDA is income before interest expense, income taxes, depreciation and amortization. We use EBITDA, in addition to net income and income/(loss) from operations, to assess our performance and believe it is important for investors to be able to evaluate us using the same measures used by management. We believe EBITDA is an important supplemental measure of operating performance because it provides investors with an indication of our performance independent of our debt and equity structure and related costs. We also believe EBITDA is a supplemental measurement tool used by analysts and investors to help evaluate a company's overall operating performance by including only transactions related to core cash operating business activities. EBITDA as calculated by us is not necessarily comparable to similarly titled measures reported by other companies. In addition, EBITDA is not prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), and should not be considered an alternative for net income, income from operations or other financial information determined under GAAP, and should not be considered as a measure of profitability or liquidity. We believe the line on the consolidated statement of operations entitled net income/(loss) is the most directly comparable GAAP measure to EBITDA. EBITDA, as calculated above, includes interest income, loss on extinguishment of debt, costs related to the sale of VITAS to the Company and costs related to the settlement of class action litigation as follows (in thousands): 2004 2005 --------------------------------------- ---------------------- First Quarter ----------------------------- January 1 February 24 to to Fourth Fourth Year-to-date February 23 September 30(a) Quarter Quarter December ----------- --------------- ------- ------- ------------ Interest income $ 41 $610 $ 481 $ 842 $ 2,803 Loss on extinguishment of debt 4,497 -- -- -- -- Costs related to sale of business 24,956 -- 1,680 -- -- Settlement of class action litigation -- -- -- 17,350 17,350 52
2004 2005 ----------------------- ------------------------- Fourth Year-to-Date Fourth Year-to-Date Quarter December Quarter December -------- ------------ -------- ------------ OPERATING STATISTICS Net revenue Homecare $ 98,746 $364,962 $117,154 $436,596 Inpatient 19,131 74,905 22,828 86,127 Continuous care 24,400 91,733 29,012 106,417 -------- -------- -------- -------- Total $142,277 $531,600 $168,994 $629,140 ======== ======== ======== ======== Net revenue as a percent of total Homecare 69.4% 68.7% 69.3% 69.4% Inpatient 13.4 14.1 13.5 13.7 Continuous care 17.2 17.2 17.2 16.9 -------- -------- -------- -------- Total 100.0% 100.0% 100.0% 100.0% ======== ======== ======== ======== Average daily census ("ADC") (days) Homecare 5,053 4,763 6,030 5,797 Nursing home 3,241 3,107 3,417 3,312 -------- -------- -------- -------- Routine homecare 8,294 7,870 9,447 9,109 Inpatient 366 367 421 408 Continuous care 474 457 544 513 -------- -------- -------- -------- Total 9,134 8,694 10,412 10,030 ======== ======== ======== ======== Total Admissions 11,558 46,537 12,487 50,456 Average length of stay (days) 64.1 60.0 70.0(a) 67.4 Median length of stay (days) 12.0 12.0 13.0 12.0 ADC by major diagnosis Neurological 31.4% 31.2% 32.5% 32.1% Cancer 21.9 22.7 21.0 21.3 Cardio 15.0 14.6 14.9 15.0 Respiratory 7.1 7.3 7.0 7.1 Other 24.6 24.2 24.6 24.5 -------- -------- -------- -------- Total 100.0% 100.0% 100.0% 100.0% ======== ======== ======== ======== Admissions by major diagnosis Neurological 18.3% 18.7% 19.3% 18.9% Cancer 37.0 37.0 37.5 36.8 Cardio 13.2 13.2 12.4 13.2 Respiratory 6.6 7.2 6.7 7.1 Other 24.9 23.9 24.1 24.0 --------- -------- -------- -------- Total 100.0% 100.0% 100.0% 100.0% ======== ======== ======== ======== Direct patient care margins (b) Routine homecare 51.2% 50.0% 50.8% 50.2% Inpatient 23.9 24.4 23.7 22.7 Continuous care 18.6 18.8 20.4 18.9 Homecare margin drivers (dollars per patient day) Labor costs $ 44.08 $ 42.96 $ 47.13 $ 45.98 Drug costs 7.63 8.48 7.31 7.60 Home medical equipment 5.56 5.71 5.46 5.48 Medical supplies 1.98 1.98 2.14 2.17 Inpatient margin drivers (dollars per patient day) Labor costs $ 235.01 $ 213.28 $ 238.26 $ 240.00 Continuous care margin drivers (dollars per patient day) Labor costs $ 437.43 $ 426.46 $ 442.28 $ 441.95 Bad debt expense as a percent of revenues 0.9% 1.0% 0.9% 0.9% Accounts receivable -- days of revenue outstanding 38.1 38.1 41.8 41.8 - ---------- (a) VITAS has five large (greater than 450 ADC), 16 medium (greater than 200 but less than 450 ADC) and 18 small (less than 200 ADC) hospice programs. 2 programs, including the Phoenix program, have estimated Medicare Cap cushion of less than 10% for the 2006 measurement period. (b) Amounts exclude indirect patient care and administrative costs. 53
Chemed Corporation and Subsidiary Companies CORPORATE GOVERNANCE We submitted our Annual Certification of the Chief Executive Officer to the New York Stock Exchange ("NYSE") regarding the NYSE corporate governance listing standards on May 18, 2005. We also filed our Certifications of the President and Chief Executive Officer, the Vice President and Chief Financial Officer and the Vice President and Controller pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1, 31.2 and 31.3, respectively, to our Annual Report on Form 10-K for the year ended December 31, 2005. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 REGARDING FORWARD-LOOKING INFORMATION In addition to historical information, this report contains forward-looking statements and performance trends that are based upon assumptions subject to certain known and unknown risks, uncertainties, contingencies and other factors. Such forward-looking statements and trends include, but are not limited to, the impact of laws and regulations on our operations, our estimate of future effective income tax rates and the recoverability of deferred tax assets. Variances in any or all of the risks, uncertainties, contingencies, and other factors from our assumptions could cause actual results to differ materially from these forward-looking statements and trends. Our ability to deal with the unknown outcomes of these events, many of which are beyond our control, may affect the reliability of our projections and other financial matters. 54
4 CORPORATE OFFICERS EDWARD L. HUTTON Chairman of the Board KEVIN J. MCNAMARA President & Chief Executive Officer DAVID P. WILLIAMS Vice President & Chief Financial Officer TIMOTHY S. O'TOOLE Executive Vice President SPENCER S. LEE Executive Vice President ARTHUR V. TUCKER, JR. Vice President & Controller NAOMI C. DALLOB Vice President & Secretary THOMAS C. HUTTON Vice President THOMAS J. REILLY Vice President LISA A. DITTMAN Assistant Secretary DIRECTORS EDWARD L. HUTTON Chairman of the Board, Chemed Corporation KEVIN J. MCNAMARA President & Chief Executive Officer, Chemed Corporation DONALD BREEN, JR.(2) President, Castle Hill Ventures LLC (management consulting and investments)
5 CHARLES H. ERHART, JR. (1, 2*, 3*) Former President, W.R. Grace & Co. (retired) JOEL F. GEMUNDER (3) President & Chief Executive Officer, Omnicare Inc. PATRICK P. GRACE (1, 3) President, MLP Capital Inc. (real estate and mining) THOMAS C. HUTTON Vice President, Chemed Corporation WALTER L. KREBS (1) Former Senior Vice President - Finance, Chief Financial Officer and Treasurer, Service America Systems Inc. (retired) SANDRA E. LANEY Chairman & Chief Executive Officer, Cadre Computer Resources Co. TIMOTHY S. O'TOOLE Executive Vice President, Chemed Corporation; President & Chief Executive Officer, VITAS Healthcare Corporation DONALD E. SAUNDERS (1*) Markley Visiting Professor, Farmer School of Business Administration, Miami University (Ohio) GEORGE J. WALSH III Partner, Thompson Hine LLP (law firm, New York, New York) FRANK E. WOOD (2) President and Chief Executive Officer, Secret Communications LLC (radio stations); Principal, The Darwin Group (venture capital); and Chairman, 8e6 Technologies Corporation (software development) 1) Audit Committee 2) Compensation/Incentive Committee 3) Nominating Committee * Committee Chairman
6 INSIDE BACK COVER TEXT: CORPORATE INFORMATION CORPORATE HEADQUARTERS Chemed Corporation Suite 2600 255 East Fifth Street Cincinnati, Ohio 45202-4726 513-762-6900 www.chemed.com TRANSFER AGENT & REGISTRAR Individuals of record needing address changes, account balances, account consolidations, replacement of lost certificates or lost checks, dividend reinvestment plan statements or cost-basis data, 1099s, or assistance with other administrative matters relating to their Chemed Capital Stock should direct their inquiries to: Wells Fargo Bank, N.A., Shareowner Services P.O. Box 64854 St. Paul, Minnesota 55164-0854 Telephone: 800-468-9716 (TOLL-FREE) Web site: www.wellsfargo.com/shareownerservices All questions relating to administration of Chemed stock must be handled by Wells Fargo. CORPORATE INQUIRIES Annual reports, press releases, corporate governance guidelines, Board committee charters, Policies on Business Ethics, the Annual Report on Form 10-K, and other printed materials may be obtained from Chemed Investor Relations without charge by writing or by calling 800-2CHEMED or 800-224-3633. Printed materials may also be viewed and downloaded from Chemed's Web site at www.chemed.com.
7 INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP Cincinnati, Ohio 45202 DIVIDEND REINVESTMENT PLAN FOR HOLDERS OF 25 OR MORE SHARES The Chemed Automatic Dividend Reinvestment Plan is available to shareholders of record owning a minimum of 25 shares of Chemed Capital Stock. A plan brochure, including fee schedule, and enrollment information are available from the Dividend Reinvestment Agent, Wells Fargo Bank, N.A., at the address listed above. ANNUAL MEETING The Annual Meeting of Shareholders of Chemed Corporation, will be held on Monday, May 15, 2006, at 11 a.m. in the Lower Level Conference Center of The Queen City Club, 331 East Fourth Street, Cincinnati, Ohio. NUMBER OF SHAREHOLDERS The approximate number of shareholders of record of Chemed Capital Stock was 3,174 on December 31, 2005. (This number does not include shareholders with shares held under beneficial ownership or within clearinghouse positions of brokerage firms and banks.) STOCK EXCHANGE LISTINGS Chemed Capital Stock is listed on the New York Stock Exchange under the ticker symbol CHE. CAPITAL STOCK & DIVIDEND DATA
8 The high and low closing prices for Chemed Capital Stock and dividends per share paid by quarter, each adjusted for a 2-for-1 stock split occurring May 11, 2005, follow: Closing --------------------- Dividends High Low Paid ------- -------- --------- 2005 FIRST QUARTER .......... $ 38.63 $ 32.55 $ 0.06 SECOND QUARTER ......... 43.83 34.57 0.06 THIRD QUARTER .......... 44.90 39.32 0.06 FOURTH QUARTER ......... 54.00 40.13 0.06 2004 First Quarter .......... $ 33.48 $ 24.48 $ 0.06 Second Quarter ......... 27.65 21.55 0.06 Third Quarter .......... 28.13 21.36 0.06 Fourth Quarter ......... 33.72 27.56 0.06
9 BACK COVER: Chemed Corporation 2600 Chemed Center 255 East Fifth Street Cincinnati, Ohio 45202-4726 Visit our Web sites at www.chemed.com, www.rotorooter.com, and www.vitas.com. RECYCLED PAPER LOGO Printed on recycled paper
EXHIBIT 21 SUBSIDIARIES OF CHEMED CORPORATION The following is a list of subsidiaries of the Company as of December 31, 2005: Other subsidiaries which have been omitted from the list would not, when considered in the aggregate, constitute a significant subsidiary. Each of the companies is incorporated under the laws of the state following its name. The percentage given for each company represents the percentage of voting securities of such company owned by the Company or, where indicated, subsidiaries of the Company as of December 31, 2005. All of the majority owned companies listed below are included in the consolidated financial statements as of December 31, 2005. CCR of Ohio, Inc. (Delaware, 100%) Comfort Care Holdings Co. (Nevada, 100%) Complete Plumbing Services, Inc. (New York, 49% by Roto-Rooter Services Company; included within the consolidated financial statements as a consolidated subsidiary) Consolidated HVAC, Inc. (Ohio, 100% by Roto-Rooter Services Company) Jet Resource, Inc. (Delaware, 100%) Nurotoco of Massachusetts, Inc. (Massachusetts, 100% by Roto-Rooter Services Company) Nurotoco of New Jersey, Inc. (Delaware, 80% by Roto-Rooter Services Company) Roto-Rooter Canada, Ltd. (British Columbia, 100% by Roto-Rooter Services Company) Roto-Rooter Corporation (Iowa, 100% by Roto-Rooter Group, Inc.) Roto-Rooter Development Company (Delaware, 100% by Roto-Rooter Corporation) Roto-Rooter Group, Inc. (Delaware, 100%) Roto-Rooter Services Company (Iowa, 100% by Roto-Rooter Group, Inc.) RR Plumbing Services Corporation (New York, 49% by Roto-Rooter Group, Inc.; included within the consolidated financial statements as a consolidated subsidiary) R.R. UK, Inc. (Delaware, 100% by Roto-Rooter Group, Inc.) VITAS Healthcare Corporation (Delaware, 100% by Comfort Care Holdings Co.) VITAS Hospice Services, L.L.C. (Delaware, 100% by VITAS Healthcare Corporation) VITAS Healthcare Corporation of Arizona (Delaware, 100% by Vitas Hospice Services, L.L.C.) VITAS Healthcare Corporation of California (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of Illinois (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of Central Florida (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of Florida (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of Ohio (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation Atlantic (Delaware, 100% by VITAS Hospice Services, L.L.C.)
VITAS Healthcare of Texas, L.P. (Texas, 99% by VITAS Holdings Corporation, the limited partner, 1% by VITAS Hospice Services, L.L.C., the general partner) VITAS Healthcare Corporation Midwest (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of Georgia (Delaware, 100% by VITAS Hospice Services, L.L.C.) VITAS Healthcare Corporation of North Florida, Inc. (Florida, 100% by VITAS Hospice Services, L.L.C.) VITAS HME Solutions, Inc. (Delaware, 100% by VITAS Hospice Services, L.L.C.) Hospice Care Incorporated (Delaware, 100% by VITAS Hospice Services, L.L.C.) Hospice, Inc. (Florida, 100% by VITAS Hospice Services, L.L.C.) VITAS Holdings Corporation (Delaware, 100% by VITAS Hospice Services, L.L.C.)
EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-115270) and Form S-8 (Nos. 2-87202, 2-80712, 33-65244, 33-61063, 333-109104, 333-118714, 333-34525, 333-87071, 333-34525 and 333-87073) of Chemed Corporation of our report dated March 13, 2006 relating to the financial statements, management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated March 16, 2006 relating to the financial statement schedule, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Cincinnati, Ohio March 16, 2006
EXHIBIT 24 POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 3, 2006 /s/ Donald Breen, Jr. ----------------------------- Donald Breen, Jr.
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 8, 2006 /s/ Charles H. Erhart, Jr. ----------------------------- Charles H. Erhart, Jr.
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 10, 2006 /s/ Joel F. Gemunder ----------------------------- Joel F. Gemunder
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 8, 2006 /s/ Patrick P. Grace ----------------------------- Patrick P. Grace
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 6, 2006 /s/ Edward L. Hutton ----------------------------- Edward L. Hutton
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 3, 2006 /s/ Thomas C. Hutton ----------------------------- Thomas C. Hutton
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as her true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 3, 2006 /s/ Sandra E. Laney ----------------------------- Sandra E. Laney
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 7, 2006 /s/ Timothy S. O'Toole ----------------------------- Timothy S. O'Toole
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 9, 2006 /s/ Donald E. Saunders ----------------------------- Donald E. Saunders
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 3, 2006 /s/ George J. Walsh III ----------------------------- George J. Walsh III
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 6, 2006 /s/ Frank E. Wood ----------------------------- Frank E. Wood
POWER OF ATTORNEY The undersigned director of CHEMED CORPORATION ("Company") hereby appoints EDWARD L. HUTTON, KEVIN J. MCNAMARA and NAOMI C. DALLOB as his true and lawful attorneys-in-fact for the purpose of signing the Company's Annual Report on Form 10-K for the year ended December 31, 2005, and all amendments thereto, to be filed with the Securities and Exchange Commission. Each of such attorneys-in-fact is appointed with full power to act without the other. Dated: March 3, 2006 /s/ Walter L. Krebs ----------------------------- Walter L. Krebs
EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934 I, Kevin J. McNamara, certify that: 1. I have reviewed this annual report on Form 10-K of Chemed Corporation ("registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls or procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth quarter in 2005 that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 13, 2006 /s/ Kevin J. McNamara ------------------------------------- Kevin J. McNamara (President & Chief Executive Officer)
EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934 I, David P. Williams, certify that: 1. I have reviewed this annual report on Form 10-K of Chemed Corporation ("registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls or procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth quarter in 2005 that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 13, 2006 /s/ David P. Williams ------------------------------------------- David P. Williams (Vice President and Chief Financial Officer)
EXHIBIT 31.3 CERTIFICATION PURSUANT TO RULES 13a-14(a)/15d-14(a) OF THE EXCHANGE ACT OF 1934 I, Arthur V. Tucker, Jr., certify that: 1. I have reviewed this annual report on Form 10-K of Chemed Corporation ("registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls or procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth quarter in 2005 that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 13, 2006 /s/ Arthur V. Tucker, Jr. ------------------------------- Arthur V. Tucker, Jr. (Vice President and Controller)
EXHIBIT 32.1 CERTIFICATION BY KEVIN J. MCNAMARA PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as President and Chief Executive Officer of Chemed Corporation ("Company"), does hereby certify that: 1) the Company's Annual Report on Form 10-K for the year ending December 31, 2005 ("Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 13, 2006 /s/ Kevin J. McNamara --------------------------------------- Kevin J. McNamara (President and Chief Executive Officer)
EXHIBIT 32.2 CERTIFICATION BY DAVID P. WILLIAMS PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Vice President and Chief Financial Officer of Chemed Corporation ("Company"), does hereby certify that: 1) the Company's Annual Report on Form 10-K for the year ending December 31, 2005 ("Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 13, 2006 /s/ David P. Williams --------------------- David P. Williams (Vice President and Chief Financial Officer)
EXHIBIT 32.3 CERTIFICATION BY ARHTUR V. TUCKER, JR. PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned, as Vice President and Controller of Chemed Corporation ("Company"), does hereby certify that: 1) the Company's Annual Report on Form 10-K for the year ending December 31, 2005 ("Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 13, 2006 /s/ Arthur V. Tucker, Jr. ------------------------------- Arthur V. Tucker, Jr. (Vice President and Controller)